Martin Philips evaluates stocks using the security market line while also considering the transaction costs of each buy and sell decision. Philips assumes that both high and low beta stocks incur the same positive percentage transactions costs on all stock trades. Which of the following is least likely an effect of Philips' assumptions?
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A. B. C.C
Based on Martin Philips' assumptions that both high and low beta stocks incur the same positive percentage transaction costs on all stock trades, let's analyze the effects on the intercept and slope of the security market line (SML).
The security market line represents the relationship between the expected return and beta of a stock. It is a graphical representation of the capital asset pricing model (CAPM), which states that the expected return of a security is equal to the risk-free rate plus a risk premium based on the stock's beta.
The intercept of the security market line represents the risk-free rate, which is the return expected from an investment with no risk. In this case, since Martin Philips is considering transaction costs, the intercept of the SML will be affected.
A. The intercept of the security market line will increase for buy signals. If transaction costs are taken into account, buying a stock would involve additional expenses, reducing the return. As a result, the intercept of the SML will increase for buy signals to reflect the higher cost of trading. Therefore, option A is likely to be true.
B. The intercept of the security market line will decrease for sell signals. Similar to buy signals, selling a stock would also incur transaction costs. These costs would reduce the return from selling, leading to a decrease in the intercept of the SML. Therefore, option B is likely to be true.
C. The slope of the security market line will increase for both buy and sell signals. The slope of the security market line represents the risk premium, which is the additional return required for taking on higher systematic risk (beta). Martin Philips assumes that high and low beta stocks incur the same positive percentage transaction costs on all stock trades. This assumption does not directly affect the relationship between beta and the risk premium. Therefore, the slope of the SML is unlikely to be affected by Martin Philips' assumptions. Option C is least likely to be true.
In summary, Martin Philips' assumptions about transaction costs would affect the intercept of the security market line, increasing it for buy signals and decreasing it for sell signals. However, these assumptions are unlikely to affect the slope of the SML, which represents the relationship between beta and the risk premium.