$b_i=\frac{{}_{iM}{}_i}{{}_M}$

a$.$ Substitute this expression for beta into the Security Market Line $($SML$),$ equation below.

$SML$:$r_i=r_{RF}+(r_M-r_{RF})b_i=r_{RF}+(R{P}_M)b_i$

This results in an alternative form of the SML$.$

I. $r_i=r_{RF}+(r_M+r_{RF}{)}^{\frac{{}_{iM}{}_i}{{}_M}}$

II$.r_i=r_M+(r_M-r_{RF}{)}^{\frac{{}_{iM}{}_i}{{}_M}}$

III. $r_i=r_{RF}+(r_M-r_{RF}{)}^{\frac{{}_{iM}{}_i}{{}_M}}$

IV$.r_i=r_{RF}+(r_{RF}-r_M{)}^{\frac{{}_{iM}{}_i}{{}_M}}$

The correct equation is $.$

b$.$ Compare your answer to part a with the Capital Market Line $($CML$),$ equation below.

$CML$:hat$(r{)}_p=r_{RF}+(\frac{\text{h}\text{a}\text{t}(r{)}_M-r_{RF}}{{}_M}){}_p$

What similarities do you observe? What conclusions can you drawn?

When in this form, the CML and SML $[$

The measure of risk in the

is ${}_p.$ The measure of risk in the

is ${}_{im}{}_i,$ and is

than for all assets except those which are perfectly positively

correlated with the market.