Question

QUESTION 17

1. Which of the following statements is most correct?

   		a. An increase in expected inflation could be expected to increase the required return on a riskless asset and on an average stock by the same amount, other things held constant.
   		b. A graph of the SML would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
   		c. If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
   		d. If investors became more averse to risk, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
   		e. The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.

Answer 1

When there would be an increase in the expected inflation, that would be expected to increase the required return on a riskless asset because the increase in expected return of riskless asset and average stock by will be of same amount.

when there would be constant risk free rate and constant market risk premium then the increase in inflation will be leading to increase in expected return by same amount of both the risk free Assets and average assets.

other statements are not correct because they are not representing the correct scenarios.

Correct answer would be option (A).