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Chapter 17: Q10. (page 369)

If the Fed increases interest rates, the SML will shift _______ and asset prices will _______.

  1. down; rise

  2. down; fall

  3. up; rise

  4. up; fall

Short Answer

Expert verified

The correct option is (d): up; fall

Step by step solution

01

Step 1. Explanation

SML vertical intercept shifts upward with the increase in the rate of interest by the Fed. The rate of return on a risky asset will increase, leading to a decrease in price as the price is inversely related to its return. Thus, the asset price will fall. Hence, the SML will shift up, and asset prices will fall.

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Most popular questions from this chapter

Why is it reasonable to ignore diversifiable risk and care only about non-diversifiable risk? What about investors who put all their money into only a single risky stock? Can they properly ignore diversifiable risk?

What determines the vertical intercept of the Security Market Line (SML)? What determines its slope? And what will happen to an asset’s price if it initially plots onto a point above the SML?

Suppose that the Federal Reserve thinks that a stock market bubble is occurring and wants to reduce stock prices. What should it do to interest rates?

If an investment has 35 percent more non-diversifiable risk than the market portfolio, its beta will be:

  1. 35

  2. 1.35

  3. 0.35

Suppose that you invest $100 today in a risk-free investment and let the 4 percent annual interest rate compound. Rounded to full dollars, what will be the value of your investment 4 years from now?
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