Which of the following statements regarding the security market line (SML) are FALSE? A) An expectation that risk has increased in the market will cause an upward parallel shift in the SML. B) An increase in inflation will cause an upward parallel shift in the SML. C) A decrease in economic growth will cause a downward parallel shift in the SML. D) An expectation that risk has decreased in the market will cause the slope of the SML to flatten. Which of the following reasons explain why U.S. investors are not well diversified internationally? I. The complications of foreign tax laws. II. International trading costs are higher than domestic trading costs. III. The poor diversification potential presented by emerging market securities. IV. SEC accounting requirements keep many foreign firms from registering in the U.S. A) I and III only. B) II and IV only. C) I, II, III, and IV. D) I, II, and IV only. If there are two assets that are perfectly positively correlated, what would be their combined standard deviation if 30 percent of an investor’s funds were put in the asset with a standard deviation of .3 and 70 percent were invested in an asset with a standard deviation of .4? A) .151. B) .244. C) .426. D) .370.
A D I got 0.1369 in the last question
A) An expectation that risk has increased in the market will cause an upward parallel shift in the SML. D) I, II, and IV only. D) .370. edit: heha168, you forgot to take the square root, what you posted is the variance (sd^2)
- A 2) D 3)D
ooooo you are right! hope I won’t make that much stupid mistakes next week
Have you guys come across these questions before? because sharp you are scoring 100% on my questions. Also, where can I read about Q1, and Q2, which chapter?
can somebody elaborate on the movements and shifts in the SML? S
Explanation on 1A?
Actually, I see why a change in risk view changes slope and does not shift curve… have to have a focal point at a risk free asset on the y-axis.
A) An expectation that risk has increased in the market will cause an upward parallel shift in the SML. if you take a look at the SML, it plots expected return on the vertical axis and risk on the horizontal so if anything, if risk has increased, you will be earning less return per unit of risk and not more efficient frontier will move down and the SML will become flatter (assuming RFR stays the same)
Sharp can you explain first one please ? An increased risk will result in higher return expectation at every risk level, and hence a parallel upward shift … why will an expectation lead to a steeper SML ?? Thanks
supersharpshooter Wrote: ------------------------------------------------------- > A) An expectation that risk has increased in the > market will cause an upward parallel shift in the > SML. > > if you take a look at the SML, it plots expected > return on the vertical axis and risk on the > horizontal > > so if anything, if risk has increased, you will be > earning less return per unit of risk and not more > > efficient frontier will move down and the SML will > become flatter (assuming RFR stays the same) I that case when risk has decreased the SML will slope upwards. What about option D ? it must be false too
Isn’t D False also then? a decrease in risk should steepen the SML
the function for the slope of the SML has a denominator of market variance which is a measure of risk. as risk decreases (increases), the slope gets larger (smaller), therefore its steeper (flatter).
Thats right, and looks like its false because option A says upward parallel shift. How do you determine when its parallel shift and when its a change in slope ? I was under impression any change in expectations will cause a shift.
hmm, i think i might have been wrong on the slope change
yep, pretty sure i was wrong about the slope, i think it is a shift http://www.investopedia.com/study-guide/cfa-exam/level-1/portfolio-management/cfa3.asp When a shift in the SML occurs, a change that affects all investments’ risk versus return profile has occurred. A shift of the SML can occur with changes in the following: 1. Expected real growth in the economy. 2. Capital market conditions. 3. Expected inflation rate.
well the thing is, a change in the RFR is a change in the intercept, which would be a parallel shift. BUT, RFR is subtracted in the numerator of the slope. therefore an increase in RFR would also decrease the slope. anyone?
my question is, shouldn’t the risk free rate also move for it to be a parallel shift??
A will make the slope of SML steep, not flat. (this is something the book says, but I don’t understand, if risk is going up, i thought the SML will become flatter. )