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Security Market Line: Basics

  • Diversifiable Risk and Systematic Risk
  • Investors are compensated only for bearing Systematic Risk
  • Market risk premium: Additional return over the risk-free rate, required to compensate investors for assuming an average amount of risk. Its size depends on the perceived risk of the stock market and investors’ degree of risk aversion

  • A measure of market risk: Beta
  • The tendency of a stock to move up or down with the market is reflected in its beta coefficient
  • Indicates how risky a stock is if the stock is held in a well-diversified portfolio

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