Question

Which of the following statements is CORRECT?a. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.b. Portfolio diversification reduces the variability of returns on an individual stock.c. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.d. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.e. A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.

Answer 1

The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.

Explanation: The SML can help to determine whether an investment product would offer a favorable expected return compared to its level of risk. The formula for plotting the SML is: Required Return = Risk-Free Rate of Return + Beta (Market Return - Risk-Free Rate of Return).