How does inflation change affect a firm’s security market line (SML)? How does investors risk aversion...

How does inflation change affect a firm’s security market line (SML)? How does investors risk aversion change affect a firm’s security market line (SML)?

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Impact on Inflation change on Firms Security Market Line( SML)

The SML ie. Security market line represents graphically the CAPM model that plots required rate of return and the risk on the y and x axis respectively and the risk free rate reffered to government securities by adding real inflation free rate and Inflation premium ie r* + IP so therefore increase in inflation premium will shift the SML upward and due to increase in inflation the risk free rate increases and this inturn will increase rate of return.

Impact on change in Investors Risk Aversion on Firms Security Market Line( SML)

The steeper the slope of the SML curve becomes higher is the investors risk aversion because the more and more investor would expect to be compensated for bearing the risk and If the investor has least or zero risk bearing power that implies no risk premium and therrefore no change in Security market line and it's flat and horizontal.

jeff jeffy answered 1 year ago

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