Question

Which of the following statements are FALSE?

I. The Security Market Line (SML) displays the relationship between expected return on investment and standard deviation of return. If a security plots below the SML, it is offering too little return to justify its risk.

II. If a stock lies below the SML, it is overpriced and it presents a selling opportunity.

III. The expected return on an investment with a beta of 2.0 is twice as high as the expected return on the market.

IV. The CAPM implies that if you could find an investment with a negative beta, its expected return would be less than the risk-free rate of return.

a) I and II only

b) I and III only

c) II and IV only

d) I, II, III and IV

Answer 1

SML is a line which shows the relationship between expected return on investment and beta of return and not standard deviation of return. So I is incorrect.

If a stock lies above the SML it indicated undervalue and a buying opportunity and if it lies below, it indicates selling opportunity. So II is correct

A beta of 2 does not indicate that the expected return on an investment is twice that of market, on the contrary it indicates that the systematic risk component on the security is twice that of market.So III is incorrect.

In CAPM, if there is a negative beta, it means that the expected return would be less than the risk free rate of return. So answer is correct

Answer is  b) I and III only