False Statements about Security Market Line (SML)

C

The SML intersects the y-axis at the nominal risk-free rate. The other choices are true.

The correct answer is B. The statement that the SML will rotate in response to changes in investor attitude toward risk is FALSE.

The security market line (SML) is a graphical representation of the relationship between the expected return and the systematic risk (beta) of an individual investment or portfolio. It is derived from the capital asset pricing model (CAPM), which is a widely used method for estimating the expected return on an investment based on its systematic risk.

Let's analyze each of the statements to understand why B is false and the other statements are true:

A. Movement along the SML indicates a change in risk characteristics of the individual investment. This statement is true. When an individual investment moves along the SML, it means there has been a change in its risk characteristics, such as a change in beta (systematic risk). Movements along the SML represent changes in expected return based on changes in the risk profile of the investment.

B. The SML will rotate in response to changes in investor attitude toward risk. This statement is false. The SML itself does not rotate in response to changes in investor attitude toward risk. The SML is a straight line that represents the expected return required by investors for a given level of systematic risk. Changes in investor attitude toward risk may lead to changes in the required expected return for a particular investment, but this would cause a shift of the entire SML rather than a rotation.

C. The SML intersects the y-axis at the real risk-free rate. This statement is true. The SML intersects the y-axis (vertical axis) at the point representing the real risk-free rate. The risk-free rate is the rate of return on an investment with no risk, typically represented by the yield on government bonds. The SML starts from this point, as investments with no systematic risk should offer at least the risk-free rate of return.

D. Changes in market conditions will cause the SML to shift up or down in a parallel manner. This statement is true. Changes in market conditions, such as shifts in the overall risk and return expectations or changes in macroeconomic factors, can cause the entire SML to shift up or down. The SML represents the required return for investments at different levels of systematic risk. If market conditions change, investors' required returns will change, leading to a parallel shift of the SML.

In summary, statement B is false because the SML does not rotate in response to changes in investor attitude toward risk. The other statements (A, C, and D) are true and accurately describe the characteristics of the security market line.