If the market risk premium decreases by 1 percent while the risk-free rate remains the same, the security market line:
a. Becomes steeper.
b. Becomes flatter.
c. Parallel shifts downward.

Janet Bellows, a portfolio manager, is attempting to explain asset valuation to a junior colleague, Bill Clay. Ms. Bellows€™s explanation focuses on the capital asset pricing model (CAPM). Of particular interest is her discussion of the security market line (SML) and its use in security selection. After a short review of the CAPM and SML, Ms. Bellows decides to test Mr. Clay€™s knowledge of valuation using the CAPM. Ms. Bellows provides the following information for Mr. Clay:

• The risk-free rate is 7 percent.
• The market risk premium during the previous year was 5.5 percent.
• The standard deviation of market returns is 35 percent.
• This year, the market risk premium is estimated to be 7 percent.
• Stock A has a beta of 1.30 and is expected to generate a 15.5 percent return.
• The correlation of stock B with the market is .88.
• The standard deviation of stock B€™s returns is 58 percent.

Then Ms. Bellows provides Mr. Clay with the following information about Ohio Manufacturing, Texas Energy, and Montana Mining:

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Texas Ohio Montana Beta 0.50 1.50 Required return 11.0% 10.5% Expected return 12.0% 10.0% 15.0% S&P 500 expected return 14.0%