Security Market Line

C

If economic growth decreases, the SML will experience a downward parallel shift. Investors who supply capital demand a lower rate.

Let's analyze each statement to determine which one is incorrect:

A. risk perception increases, the SML will rotate counterclockwise.

This statement is correct. In the context of the security market line (SML), risk perception refers to investors' subjective views on the level of risk associated with an investment. When risk perception increases, investors demand higher expected returns for taking on additional risk. As a result, the SML will rotate counterclockwise to reflect the higher expected returns needed to compensate for the increased risk. This statement is accurate.

B. inflation expectations increase, the SML will experience an upward parallel shift.

This statement is correct. Inflation expectations have a significant impact on the SML. When inflation expectations increase, investors require higher nominal returns to maintain the same purchasing power in the future. Consequently, the SML will shift upward in a parallel manner to reflect the higher expected returns across all levels of systematic risk. This statement is accurate.

C. economic growth decreases, the SML will experience an upward parallel shift.

This statement is incorrect. Economic growth and the SML are not directly related in a way that would cause an upward parallel shift. The SML reflects the relationship between expected return and systematic risk for an individual security or portfolio. While economic factors, such as GDP growth, can affect the overall level of expected returns, they do not cause a parallel shift in the SML. Instead, changes in economic growth are more likely to influence individual security prices and overall market conditions. Therefore, this statement is incorrect.

D. the capital markets tighten, the SML will experience an upward parallel shift.

This statement is correct. When the capital markets tighten, it means that there is reduced availability of credit and increased borrowing costs. In such a scenario, investors may become more risk-averse and demand higher expected returns. As a result, the SML will shift upward in a parallel manner to reflect the higher expected returns across all levels of systematic risk. This statement is accurate.

In summary, the incorrect statement is:

C. economic growth decreases, the SML will experience an upward parallel shift.