CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models
In the capital asset pricing model (CAPM), the security market line most appropriately plots the expected return of a security against its:
The security market line plots expected return against beta. CAPM prices only systematic risk, which beta measures, so required return rises linearly with beta. Total standard deviation belongs to the capital market line, and residual variance is diversifiable and earns no premium.
- AbetaCorrect
- Btotal standard deviation
- Cresidual variance
Explanation
The security market line (SML) shows required return as a linear function of systematic risk, measured by beta. Total standard deviation is the horizontal axis of the capital market line, not the SML. Residual variance is diversifiable risk and is not priced under CAPM.
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