Asked by Ja'Nayla Watts on Jun 23, 2024
Verified
According to the SML, the risk premium for stock X depends on:
A) everything about Company X.
B) Company X's earnings only.
C) only X's market risk.
D) X's total risk as reflected by its beta.
Security Market Line
A graphical representation of the expected return of investments as a function of their risk, showing how different levels of risk correlate with the market's rate of return.
Risk Premium
The extra return above the risk-free rate that investors require as compensation for the higher risk of investing in a particular asset.
Market Risk
The risk of losses in investments due to market variables, such as changes in interest rates, currency exchange rates, or stock market fluctuations.
- Comprehend the significance of variations in market conditions (such as risk-free rate and market risk premium) on the Security Market Line (SML).
- Acquire the skills necessary to compute the risk premium associated with individual securities.
Verified Answer
GA
glorious abbeyJun 24, 2024
Final Answer :
C
Explanation :
DThe Security Market Line (SML) is a concept from the Capital Asset Pricing Model (CAPM) that defines the expected return of an investment as a function of its systematic risk, as measured by beta. Choices C and D are correct because the SML specifically relates a stock's risk premium to its market risk (systematic risk) and not to its total risk or specific company characteristics. Beta reflects the stock's volatility in relation to the overall market, representing the type of risk that cannot be diversified away.
Learning Objectives
- Comprehend the significance of variations in market conditions (such as risk-free rate and market risk premium) on the Security Market Line (SML).
- Acquire the skills necessary to compute the risk premium associated with individual securities.