IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)
Under the Capital Asset Pricing Model, the Security Market Line plots expected return of a security against which quantity on the horizontal axis?
The Security Market Line plots expected return against beta. Beta measures systematic risk relative to the market portfolio. The line is straight with slope equal to the market risk premium. Total standard deviation is used on the Capital Market Line instead.
- ATotal standard deviation of the security's returns
- BVariance of the security's returns
- CBeta of the security relative to the market portfolioCorrect
- DCorrelation of the security with the risk-free asset
- Residual (specific) risk of the security
Explanation
The SML is a straight line showing expected 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, so option A confuses the two lines.
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