Conceptual Overview: Explore the determinants of the security market line.

The Security Market Line defines the required rate of return for a security to be worth buying or holding. The line, depicted in blue in the graph, is the sum of the risk-free return (rf in the slider) and a risk premium determined by the market-risk premium (RPM) multiplied by the security's beta coefficient for risk. Drag the rf slider below the graph to change the amount of the risk-free return. These changes reflect changes in inflation. Drag the RPM slider below the graph to change the relationship between a security's beta coefficient and the amount of the market risk premium. Drag left or right on the graph to move the cursor line to evaluate securities with different beta coefficients.

r = r_{RF} + RP_M * beta = 6\% + 5\% * 1 = 6\% + 5.00\% = 11.00\%r=rRF+RPMbeta=6%+5%1=6%+5.00%=11.00%

0.00.51.01.52.02.505101520Beta CoefficientReq. Rate of ReturnRisk-Free Return = 6.0%Risk Premium = 5.00%1.011% 246810rf = 6 246810RPM = 5

For a risk-free return rate of 5%, a market risk premium of 6%, what is the required rate of return for a security with a beta coefficient of 1.5?

5%

9%

14%

cannot be determined

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2. Changing the risk-free return (inflation)

Changes neither the y-intercept nor the slope of the security market line

Changes only the y-intercept of the security market line

Changes only the slope of the security market line

Changes both the y-intercept and the slope of the security market line

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3. Changing the market risk premium

Changes neither the y-intercept nor the slope of the security market line

Changes only the y-intercept of the security market line

Changes only the slope of the security market line

Changes both the y-intercept and the slope of the security market line

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4. True or False: If a company's beta doubles, its required return doubles.

True

False

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