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FRM Part I · FRM Exam Part I · Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)

Which statement about the CAPM's Security Market Line (SML) is correct?

The SML plots expected return against beta, with the risk-free rate as the intercept and the market risk premium as the slope. Plots against total standard deviation describe the Capital Market Line, not the SML.

  1. AThe SML plots expected return against standard deviation, and efficient portfolios lie on it.
  2. BThe SML plots expected return against beta, and its slope equals the market risk premium.Correct
  3. CThe SML plots expected return against beta, and its intercept equals the market's expected return.
  4. DThe SML plots expected return against beta, and its slope equals the risk-free rate.

Explanation

The SML graphs expected return against systematic risk (beta). Its intercept is the risk-free rate and its slope is E(Rm) - Rf, the market risk premium. Plotting against standard deviation describes the Capital Market Line instead.

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