The Security Market Line (SML) shows the relationship between stocks' required rates of return (measured on the vertical axis) and their betas (measured on the horizontal axis). The vertical axis intercept is the required rate of return on a riskless asset, and the required rate of return associated with b = 1.0 is the required rate of return on "the market." The difference between the required rate of return on the market and that on the riskless asset (rM - rRF) is defined as the "market risk premium." The steeper the SML, the larger the market risk premium, and the greater the average investor's aversion to risk. True or false?

Question

Business

Francesca Hicks

15 July, 14:16

The Security Market Line (SML) shows the relationship between stocks' required rates of return (measured on the vertical axis) and their betas (measured on the horizontal axis). The vertical axis intercept is the required rate of return on a riskless asset, and the required rate of return associated with b = 1.0 is the required rate of return on "the market." The difference between the required rate of return on the market and that on the riskless asset (rM - rRF) is defined as the "market risk premium." The steeper the SML, the larger the market risk premium, and the greater the average investor's aversion to risk. True or false?

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Answers (1)

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Jay English · Answer 1

True

Explanation:

The reason is that the straight line equation is used to illustrate the relation between the rate of return and the beta factor and is given as under:

Y = a + bX

Here

a = Rf

B = Risk premium = Rm - Rf

X = Beta Factor

So this means the security market line is the graphical presentation of capital asset pricing model and illustrates why the increase in beta factor increases the required rate of return, the reason is that the the overall required return Y of the investment will start increasing with the increase in the beta factor.

So the statement is true.