Practice Question
Match the following statements to true or false:
A) The greater the intercept of the security market line (SML), the higher the risk-free rate of return.
B) The greater the intercept of the capital market line (CML), the higher the beta of the stock.
C) Under CAPM, when the beta of a security is equal to 1, the expected return of the security is the return of the market portfolio.
D) Under CAPM, when the beta of a security is equal to 0, this security has no risk.
E) The tangency portfolio is the portfolio with the lowest standard deviation.
F) When the expected return of stock A lies above the SML, it is overpriced.
G) All portfolios on the efficient frontier have the same Sharpe Ratio.
- A) True. The intercept of the SML is the risk-free rate. A higher intercept implies a higher risk-free rate of return.
- B) False. The intercept of the CML also represents the risk-free rate—not the beta. Beta measures a stock’s sensitivity to the market and is not on the CML at all (only on the SML).
- C) True. When beta equals 1, the expected return equals the return on the market portfolio under CAPM.
- D) False. A beta of 0 means no systematic (market) risk—but the stock could still carry idiosyncratic or unsystematic risk.
- E) False. The tangency portfolio has the highest Sharpe Ratio, not the lowest standard deviation. The minimum variance portfolio would have the lowest standard deviation.
- F) False. If a stock's return lies *above* the SML, it's offering a higher return than expected for its risk—indicating it's underpriced, not overpriced.
- G) False. Portfolios on the efficient frontier have varying Sharpe Ratios. Only the tangency portfolio (intersection with the CML) maximizes it.