The market rate of return is 12% and the risk-free rate of return is 4%. A stock that has 5% more risk than the market has an actual return of 12%. Given this information, the stock will plot below the security market line.

Question

Quizplus · Accepted Answer

The stock's expected return, based on its higher risk level compared to the market, should be greater than the market rate of return of 12% to compensate for the additional risk. Since its actual return is only 12%, the same as the market rate, it is not providing enough return for its level of risk, thus it would plot below the Security Market Line (SML), which represents expected return for a given level of risk.

The Market Rate of Return Is 12% and the Risk-Free