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What would the SML look like if investors were indifferent to risk, that is, if they...

What would the SML look like if investors were indifferent to risk, that is, if they had zero risk aversion? Explain.

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Answer #1

The SML equation shows the relationship between security's market risk and required rate of return. Required rate of return is risk free rate of return plus market risk premium times the beta of security. Required rate of return is the expected rate of return= Risk free assets (Rf)+Market Risk premium (MRp) *Beta(B).

If the risk free rate of return is 6%, the required rate of return is also 6% as there is no market risk premium because they had zero risk aversion. In that case, SML would plot as horizontal line.

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