Practice Question
Match the following statements to true or false:
A) The steeper the slope of the security market line (SML), the higher the market risk premium.
B) The steeper the slope of the capital market line (CML), the higher the Sharpe Ratio.
C) The steeper the slope of the security market line (SML), the higher the beta of the stock.
D) The intercept of the security market line (SML) is the risk-free rate.
E) The intercept of the security market line (SML) is beta.
F) Typically, one can argue that the beta of a portfolio is equal to the average of the betas of its individual stocks.
G) The expected rate of return must be equal to the required rate of return for the market to be in equilibrium.
A. TRUE B. TRUE C. FALSE D. TRUE E. FALSE F. TRUE G. TRUE
- A) True. The slope of the SML is the market risk premium. A steeper slope indicates a larger premium for bearing systematic risk.
- B) True. The slope of the Capital Market Line (CML) is the Sharpe Ratio. A steeper slope implies better risk-adjusted returns.
- C) False. Beta is an independent input into the SML formula. A steeper slope (i.e., higher market risk premium) affects required returns, not beta values.
- D) True. The SML equation starts with the risk-free rate as the y-intercept: Required Return = RF + Beta × (ERM − RF).
- E) False. The intercept is the risk-free rate, not beta. Beta appears as a slope multiplier, not the intercept.
- F) True. The beta of a portfolio is the weighted average of the individual betas of the assets in the portfolio.
- G) True. In market equilibrium, the expected return on an asset must equal the required return; otherwise, arbitrage opportunities would exist.