Question

1.1. In the context of the CAPM, explain the difference between the SML and the CML (3).

1.2. The market portfolio has an expected return of 0.12 and a standard deviation of 0.40, and the risk-free rate is 0.04. Calculate the slope of the security market (2).

1.3. Explain what the slope of the SML represents (3).

Answer #1

1.1

Answer: The **CML and SML** both show **trade
off between risk** and expected **return**. The
**difference between** the two is **CML**
measure the **risk** by standard deviation which
consist systematic and unsystematic **risk** whereas
**SML** only takes systematic **risk**
into consideration.

1.2

Answer : **Slope of SML=Expected return of
market minus risk-free rate of return**

Slope = 0.12 - 0.04 = 0.08

1.3

**Security market line
(SML)**

The security market line (SML) is the graphical representation of the Capital Asset Pricing Model (CAPM) and gives the expected return of the market at different levels of systematic or market risk. It is also called ‘characteristic line’ where the x-axis represents beta or the risk of the assets, and the y-axis represents the expected return.

**Security Market Line
Equation**

The Equation is as follows:

**SML: E(R**_{i}**) = R**_{f}**+ β**_{i}**[E(R**_{M}**) – R**_{f}**]**

In the above security market line formula:

- E(R
_{i}) is the expected return on the security - R
_{f}is the risk-free rate and represents the y-intercept of the SML - β
_{i}is a non-diversifiable or systematic risk. It is the most crucial factor in SML. We will discuss this in detail in this article. - E(R
_{M}) is expected to return on market portfolio M. - E(R
_{M}) – R_{f }is known as Market Risk Premium

The above equation can be graphically represented as below:

35. Assume the expected return on the market portfolio is 15%
and its standard deviation is 12%. The risk-free rate is 5%. Denote
the expected return and beta of securities on the Security Market
Line
(SML) with () and β, respectively. Which statement is
TRUE?
A) The beta of a CML portfolio that contain 150% of the market
portfolio and 50% borrowed money
is 1.25.
B) The SML can be represented by the following equation:
C) The slope of the...

Under the CAPM, the only way an individual stock could plot on
the CML is if it happens to have exactly the same expected return
and standard deviation as the market portfolio. True /False

Which of the following statement is FALSE? Group of answer
choices
When using all risky assets available in the market in the
market and the risk-free asset to form portfolio, we find that all
efficient portfolios are on the Capital Market Line (CML).
If the CAPM holds, then all assets will graph on the Security
Market Line (SML).
If an asset graph above the SML, then this asset is under-priced
according to the CAPM.
Portfolios on the Capital Market Line...

In the context of CAPM/SML, which of these is not true about
Beta:
it is fairly stable over time
it shows how much on average the stock price changed when the
market return moved +/- 1%
it measures unsystematic risk
it is estimated by running a regression of stock returns vs
market returns

A portfolio has the following composition:
Security
Weight
Expected Beta
A
10%
0.8
B
20%
1.1
C
30%
1.3
D
40%
0.7
What is the expected beta of the portfolio?
Stock A had a market value of $20, Stock B had a market value of
$30. During the year, Stock A generated cash flow of $3 and Stock B
generated cash flow of $4. The current market values are, Stock A
is $22 and Stock B is $31.
What is...

You have a portfolio with 60% allocation of funds to the market
portfolio and remaining amount is allocated to a risk-free asset.
The beta of your portfolio is _____ .
a.
0
b.
0.6
c.
1
d.
1.5
Which of the following statements is false?
a.
SML is the graphical representation of expected return-beta
relationship of the CAPM.
b.
Slope of SML is the market risk premium.
c.
Alpha is the abnormal rate of return on a security in excess...

If the simple CAPM is valid, which of the situation in Tables
below are possible? Explain. Consider each situation
independently
A.) Portfolio Expected Return Standard Deviation
Risk Free Rate 5% 0%
Market 21% 22%
A 20% 10%
B.) Portfolio Expected Return Beta
Risk Free 10% 0
Market 18% 1.0
A 22% 2

1. The market rate of return is 10.5% and the risk-free rate is
1.1%. What will be the change in a stock's expected rate of return
if its beta increases from 0.8 to 1.0?
18.80%
1.88%
1.62%
16.20%
2. "If the market portfolio is expected to return 13%, then a
portfolio that is expected to return 10%: "
plots above the security market line
plots to the right of the market on an SML graph.
is diversified.
has a beta...

If the simple CAPM is valid and all portfolios are priced
correctly, which of the situations below is possible? Consider each
situation independently, and assume the risk-free rate is 5%.
A)
Portfolio
Expected
Return
Beta
A
11
%
1.1
Market
11
%
1.0
B)
Portfolio
Expected
Return
Standard
Deviation
A
14
%
11
%
Market
9
%
19
%
C)
Portfolio
Expected
Return
Beta
A
14
%
1.1
Market
9
%
1.0
D)
Portfolio
Expected
Return...

If the simple CAPM is valid and all portfolios are priced
correctly, which of the situations below is possible? Consider each
situation independently, and assume the risk-free rate is 5%.
A)
Portfolio
Expected
Return
Beta
A
11
%
1.1
Market
11
%
1.0
B)
Portfolio
Expected
Return
Standard
Deviation
A
14
%
11
%
Market
9
%
19
%
C)
Portfolio
Expected
Return
Beta
A
14
%
1.1
Market
9
%
1.0
D)
Portfolio
Expected
Return
Beta
A
17.6
%...

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