Which of the following statements about risk-return relationship is correct? If

Question

Which of the following statements about risk-return relationship is correct?

If investors became more averse to risk, then the slope of the SML would become less steep

An increase in the expected inflation would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant

The market risk premium is lower for higher beta stocks and higher for lower beta stocks

A graph of the SML would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis

As a result of change in investors' risk aversion, the required rate of return on low-beta stocks is impacted more when compared to the required return on high-beta stocks

Explanation / Answer

An increase in the expected inflation would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant.

Interest yield (risk free) are based on long term yields of risk free instrments. If inflation goes up central bank shall increase the rate and yields move in tandem with inflation. Hence Rf - risk free return moves proportionately.

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