If an asset has a risk-return combination that is above the Security Market Line (SML), then arbitrage will make that asset's
A) beta increase.
B) beta decrease.
C) average expected return increase.
D) average expected return decrease.

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), assets that are above the SML have an expected return that is higher than what the market is pricing in for the level of risk. This indicates an opportunity for arbitrage, where investors can buy the undervalued asset and sell overpriced assets until the expected returns align with the market equilibrium. This will lead to a decrease in the asset's average expected return as prices adjust to the market. Therefore, the correct answer is D.

If an Asset Has a Risk-Return Combination That Is Above