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Author Question: What is the equation for the Security Market Line? Define each term. If an asset has a beta of 2.0, ... (Read 381 times)

09madisonrousseau09

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on: Jul 10, 2018
What is the equation for the Security Market Line? Define each term. If an asset has a beta of 2.0, what type of return should it realize compared to the market portfolio?
 
  What will be an ideal response?

Question 2

According to the security market line, there is no reward for waiting. In other words, in order to have any expected return at all, an investor must invest in risky assets.
 
  Indicate whether the statement is true or false.


Li Jun

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Reply #1 on: Jul 10, 2018
Answer to Question 1

Answer: The equation for the SML is E(ri) = rf + E(rm) - rf  i, where: E(ri) is the expected return on an asset, rf is the risk-free rate, i is beta the measure of nondiversifiable risk for asset i, E(rm) is the expected return for holding the market portfolio of risky assets, and E(rm) - rf is the market risk premium that an investor can expect to earn for holding the market portfolio. If an asset has a beta of 2.0, an investor can expect to receive twice the market risk premium in addition to the risk-free rate of return. A common misconception is that the investor can expect to receive twice the rate of return as the market portfolio, but only the risk premium is impacted by the level of risk.

Answer to Question 2

Answer: FALSE
Explanation: According to the security market line, there is a reward for waiting. The risk-free asset can provide you with a positive return without uncertainty of return.


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