Given the beta and expected return of ALL of the following assets, which of the following asset bundles could NOT be found on the security market line? Assume the risk free asset has an expected return of 4%.

$$\begin{array} { l c c }
\text { Asset Bundle } & \text { Beta } & \text { Expected Return } \
\text { Market Portfolio } & 1.00 & 12 \% \
\text { Bundle ABC } & 0.50 & 8 \% \
\text { Bundle AEP } & 1.50 & 14 \% \
\text { Bundle KAM } & 0.75 & 10 \%
\end{array}$$
A) The Market Portfolio
B) Bundle ABC
C) Bundle AEP
D) Bundle KAM
E) All of the above would found on the security market line

Question

Given the beta and expected return of ALL of the following assets, which of the following asset bundles could NOT be found on the security market line? Assume the risk free asset has an expected return of 4%.

$$\begin{array} { l c c } 
\text { Asset Bundle } & \text { Beta } & \text { Expected Return } \
\text { Market Portfolio } & 1.00 & 12 \% \
\text { Bundle ABC } & 0.50 & 8 \% \
\text { Bundle AEP } & 1.50 & 14 \% \
\text { Bundle KAM } & 0.75 & 10 \%
\end{array}$$
A) The Market Portfolio
B) Bundle ABC
C) Bundle AEP
D) Bundle KAM
E) All of the above would found on the security market line

Quizplus · Accepted Answer

The security market line (SML) shows the expected return of all assets given their beta. According to the CAPM equation, the expected return of an asset is equal to the risk-free rate plus the asset's beta multiplied by the market risk premium (the difference between the expected return of the market portfolio and the risk-free rate). Thus, any asset with a beta that is non-zero should lie on the SML. However, assets whose expected returns do not correspond to their betas will not lie on the SML. Bundle AEP has a beta of 1.5 and an expected return of 14%, which lies above its expected return given its beta. Therefore, Bundle AEP could not be found on the security market line.

Given the Beta and Expected Return of ALL of the Following