Please answer the following: A conservative investment advisor foresees a downturn in the economy and recommends low risk investments. An aggressive investor has a very positive outlook and recommends taking a higher risk. What advice do you take? Discuss the effect of the advice received on your long term asset allocation.Please respond to the following with informative information.1. The SML reflects the risk-return combinations available for all risky assets in the capital market at a given time (Reilly & Brown, 2012). Investors select investments that are consistent with their risk preferences. Some investors prefer only low-risk investments, while others are comfortable with high-risk investments.Reilly & Brown (2012), explain that the slope of the SML indicates the required return per unit of risk required by all investors. A change in the slope of the SML occurs any time there is a change in the attitudes of investors toward risk. Such a change shows that investors want either higher or lower rates of return for the same intrinsic risk. Reilly & Brown (2012) state that this is also described as a change in the market risk premium (Rm−NRFR).The slope of the Security Market Line is determined by market risk premium which is: (E(RM) – Rf). Wall (2020) explains the slope will increase as the market risk premium gets higher and will decrease as the market risk premium lowers. This relationship is important because a change in the market risk premium will affect all risky investments. According to Reilly & Brown (2012), a change in investors’ attitudes toward risk will cause a change in the required return per unit of risk, or in other words, a change in the market risk premium. Such a change will cause a change in the slope of the SML.ReferencesReilly, F. K., & Brown, K. C. (2012). The investment setting. Investment analysis & portfolio management (10th ed.). Mason, OH: South-Western.Wall Street Mojo. (2020). Security market line (SML). Retrieved from https://www.wallstreetmojo.com/security-market-line/2. The slope of security market line (SML) demonstrates the relationship between risk and return on assets at any given time in the capital market (Reilly & Brown, 2012). The slope of the SML provides any given combination of risk and return on investments. For each level of risk an investor considers, the slope of the SML provides the marginal return required to incur such risk. The slope of the SML can change in terms of an investment moving along the SML, a change in the slope, or a shift of the curve based on the investor’s risk preferences, attitudes, or inflation, respectively (Reilly & Brown, 2012). This concept is important to investors because their selection of investments is based on their risk preferences given the rate of return. The SML allows investors to choose investments that are going to provide marginal return to their preferred level of risk. Investors of both high and low risk tolerance can use the SML to determine which investments will provide optimal return.Reilly, F. K., & Brown, K. C. (2012). Investment Analysis & Portfolio Management. Mason, OH: South-Western Cengage Learning.3. The SML displays a line that takes into consideration the level of risk and return depending on the investment. It helps investors understand the perceived return with the level of risk that they are taking. From there, individuals can choose an investment that fits their needs depending on the amount of risk they are willing to take. The slope of the SML refers to the rate of return per unit of risk (Reilly & Brown, 2012). Depending on the level of risk associated with an asset, there can be yield spreads which show the difference between them. Over time, these yield spreads can change.The slope of the SML is extremely important as it helps display which risky investments would be offset by earning a premium, which would make the return worth the risk (Reilly & Brown, 2012). The relationship between risk and return is that return increases in response to the associated risk increasing as well. It will also show what investments are recommended with a rate of return for a lower risk option. An SML is useful in that it can be used by investors who are both high and low risk takers.Reference:Reilly, F., & Brown, K. (2012). Investment analysis & portfolio management. 10th ed. Mason, OH: South-Western.
