Which statements about the capital asset pricing model (CAPM) are CORRECT?

Which statements about the capital asset pricing model (CAPM) are CORRECT?

• A. Standard deviation is used as the measure of risk on the security market line.
• B. The CAPM formula defines the security market line.
• C. Superior performance exists if a fund's position is above the capital market line.
• D. Both portfolio risk and return decrease when investing in risky securities.

Answer: (B)

The capital asset pricing model (CAPM) is a fundamental theory in finance that describes the relationship between systematic risk and expected return for assets, particularly stocks. One of the primary elements of CAPM is the security market line (SML), which represents the expected return of a security as a function of its systematic risk, measured by beta. The SML provides a benchmark for evaluating the performance of individual securities in relation to their risk levels. The statement that the CAPM formula defines the security market line is accurate because it directly reflects how expected returns are calculated based on systematic risk. The formula itself incorporates the risk-free rate, the expected market return, and the security's beta, which allows investors to determine if a security is underpriced or overpriced relative to its risk profile. Understanding the other options provides valuable context. The use of standard deviation as a measure of risk is associated with total risk, which is not the focus of CAPM; instead, CAPM emphasizes systematic risk. Regarding the capital market line (CML), it describes the risk-return trade-off for efficient portfolios, where superior performance is indicated by a portfolio's position above this line. The idea that both portfolio risk and return decrease when investing in risky securities contradicts the fundamental principles of

The capital asset pricing model (CAPM) is a fundamental theory in finance that describes the relationship between systematic risk and expected return for assets, particularly stocks. One of the primary elements of CAPM is the security market line (SML), which represents the expected return of a security as a function of its systematic risk, measured by beta. The SML provides a benchmark for evaluating the performance of individual securities in relation to their risk levels.

The statement that the CAPM formula defines the security market line is accurate because it directly reflects how expected returns are calculated based on systematic risk. The formula itself incorporates the risk-free rate, the expected market return, and the security's beta, which allows investors to determine if a security is underpriced or overpriced relative to its risk profile.

Understanding the other options provides valuable context. The use of standard deviation as a measure of risk is associated with total risk, which is not the focus of CAPM; instead, CAPM emphasizes systematic risk. Regarding the capital market line (CML), it describes the risk-return trade-off for efficient portfolios, where superior performance is indicated by a portfolio's position above this line. The idea that both portfolio risk and return decrease when investing in risky securities contradicts the fundamental principles of