Other things held constant, if the expected inflation rate decreases and investo

Question

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:
Answer
A) The y-axis intercept would decline, and the slope would increase.
B) The x-axis intercept would decline, and the slope would increase.
C) The y-axis intercept would increase, and the slope would decline.
D) The SML would be affected only if betas changed.
E) Both the y-axis intercept and the slope would increase, leading to higher required returns.

If in the opinion of a given investor a stock's expected return exceeds its required return, this suggests that the investor thinks
A) the stock is experiencing supernormal growth.
B) the stock should be sold.
C) the stock is a good buy.
D) management is probably not trying to maximize the price per share.
E) dividends are not likely to be declared.

Explanation / Answer

Question 1: This is a pretty interest question. If you break it down into two parts it's also quite easy. The first part- inflation is decreasing. This will shift the SML down on the Y axis because every stock will have a little less return built in. The second part- investors are becoming more risk averse (they're requiring more return for more risk). This will increase the slope of the SML because has Beta increases so will the required return. The correct answer is A.

Question 2: This question isn't too hard if you just state it another way... Bill, an investor, expects Google inc. stock to perform better (higher expected return) that he requires to buy it. The correct answer is C Bill would think the stock is a good buy because he expects it to outperform his required return on it.

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