Question

Which of the following is/are TRUE?

I. The security market line can be thought of as expressing relationships between expected required rates of return and beta.
II. A stock with a beta of zero would be expected to have a rate of return equal to the risk-free rate.
III. Assume that the capital asset pricing model holds. Then, a security whose expected return falls below the SML (security market line) indicates that the security is undervalued, whereas a security whose expected return falls above the SML indicates that the security is overvalued.
IV. The beta of the market portfolio is 1.

Question 10 options:

	I, III and IV only
	II and IV only
	I and II only
	I, II and IV only
	I and III only

Answer 1

Correct answer: I, II and IV only

Security market line shows the relationship between systematic risk (Beta) and expected required rate of return.

Security above SML are undervalued and below SML are overvalued.

Beta is measure of change in security price due to change in market thus, Beta of market always 1.

Risk free assets have zero beta because market movement does not affect risk free assets.