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SML and Alpha Quiz from Investments Textbook

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SML and Alpha Quiz from Investments Textbook

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Questions and Answers

What is the Security Market Line (SML) graphed as?

A curve connecting all possible portfolios in the market

A hyperbolic curve representing the relationship between expected return and beta

An exponential curve showing the relationship between risk and return

A straight line connecting the risk-free rate to the market portfolio (correct)

Which of the following best describes the Capital Market Line?

It shows the relationship between expected return and market risk premium

It is a curve representing the equilibrium between expected return and beta

It connects the risk-free rate to a tangency portfolio in the market

It represents a set of portfolios that achieve the highest possible return for a given level of risk (correct)

In the context of CAPM, what does alpha represent?

The expected return of an asset given its beta

The systematic risk of an asset

The market risk premium

The difference between an asset's actual return and its expected return based on its beta (correct)

If an asset lies below the Security Market Line (SML), what does it imply?

The asset's return is less than what would be predicted by its beta Signup and view all the answers

Which line on a graph represents the relationship between expected return and beta according to CAPM?

Security Market Line (SML) Signup and view all the answers

What does a higher slope of the Security Market Line (SML) indicate?

Higher systematic risk in the market Signup and view all the answers

How is risk typically measured in relation to beta on the Security Market Line (SML)?

With respect to market returns Signup and view all the answers

What does a point above the Capital Market Line indicate?

An overvalued asset in the market Signup and view all the answers

'Beta' in relation to CAPM represents:

'Beta' measures an asset's volatility relative to the market Signup and view all the answers

What does 'Alpha' being positive indicate in relation to CAPM?

The asset has outperformed the market based on its systematic risk. Signup and view all the answers

Study Notes

Alpha is the difference between a stock’s expected return and its required return according to the Security Market Line (SML).
Stocks with non-zero alphas do not lie on the SML, indicating market inefficiency.
The alpha for Cisco during 2000–2017 was estimated at -0.29% with a standard error of 0.5%, which was statistically insignificant.
Alpha represents a risk-adjusted performance measure for historical returns in the Capital Asset Pricing Model (CAPM).
It is difficult to accurately estimate alpha without a long data series, and individual stock alphas have little persistence.
The Capital Asset Pricing Model (CAPM) helps identify the portfolio that maximizes Sharpe ratio for investment.
Tangency portfolio is where the risk-free asset combines with the investable universe, optimizing return and risk.
Efficient Frontier is the ideal balance between risk and return in portfolios, with the Tangency portfolio at the peak.
Adding assets to a portfolio will improve the Sharpe ratio if the risk is reduced.
Different companies have varying betas with respect to the S&P 500, indicating their volatility compared to the market.

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Description

Test your knowledge on the Security Market Line (SML) and Alpha concept based on the content from Bodie, Kane and Marcus's Investments textbook. The quiz covers topics like underpricing, required return, market portfolio efficiency, and analyzing stocks with non-zero alphas.