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=rRF+RPMbeta=5%+6%1.5=5%+9.00%=14.00%

a) What is the RF?

b) What is the RPM?

c) What is the Beta Coefficient?

1. 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

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

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

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

True

False