The Security Market Line defines the required rate of return for a security to be worth buying or holding. The line, depicted in blue in the graph, is the sum of the risk-free return (rf in the slider) and a risk premium determined by the market-risk premium (RPM) multiplied by the security's beta coefficient for risk. Drag the slider below the graph to change the relationship between a security's beta coefficient and the amount of the market risk premium. Drag left or right on the graph to move the cursor to evaluate securities with different beta coefficients. In this graph, the risk-free return is fixed at 6%.

 1.  If the market-risk premium were 4% and a security's beta coefficient were 2.0, what would be the required rate of return for the security? (The risk-free return is fixed at 6% in this graph.)
2.  If the market-risk premium doubles (say, from 4% to 8%), what is change in the required rate of return for a security?

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Req. Rate of Return 20 11% 15 10- 40 0 0.0 2 r=rRF + RPM * beta 6% + 5%* 1 = 6% + 5.00% = 11.00% 0.5 1.0 1.0 RPM = 5 4 = Risk Premium = 5.00% 6 1.5 Risk-Free Return = 6.0% 2.0 Beta Coefficient 2.5 8 10 Req. Rate of Return 20 11% 15 10- 40 0 0.0 2 r=rRF + RPM * beta 6% + 5%* 1 = 6% + 5.00% = 11.00% 0.5 1.0 1.0 RPM = 5 4 = Risk Premium = 5.00% 6 1.5 Risk-Free Return = 6.0% 2.0 Beta Coefficient 2.5 8 10

Answer rating: 100% (QA)

As per the capital assets pricing model CAPM the expected return of the security is calculated as fo... View the full answer