Which of the following statements about the security market line (SML) are true?
a. The SML provides a benchmark for evaluating expected investment performance.
b. The SML leads all investors to invest in the same portfolio of risky assets.
c. The SML is a graphic representation of the relationship between expected return and beta.
d. Properly valued assets plot exactly on the SML.
Statements a, c, and d are true.
The representation of Capital Asset Pricing Model on graph is known as Security Market Line (SML). It displays the expected return of a security as a function of various risks.
From the above definition, since the SML gives a benchmark for evaluating expected returns of an investment and graphically displays the relationship between expected returns and β where the X axis is the systematic risks (measured in β) and Y axis is the expected returns, the correct statements from the options above would be a, c and d.
Use the following data in answering CFA Questions:
Investor “satisfaction” with portfolio increases with expected return and decreases with variance according to the “utility” formula: U = E(r) - ½ Aσ2 where A = 4.
Question: Based on the formula for investor satisfaction or “utility,” which investment would you select if you were risk averse with A = 4?
Are the following true or false? Explain.
a. Stocks with a beta of zero offer an expected rate of return of zero.
b. The CAPM implies that investors require a higher return to hold highly volatile securities.
c. You can construct a portfolio with beta of .75 by investing .75 of the investment budget in T-bills and the remainder in the market portfolio.
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