A. The Security Market Line tells us what investors’ required rates of return are at each level of risk as measured by the stock's beta. However, the slope of a stock's Security Market Line is not the graphical representation of the security's risk.
B. The Security Market Line tells us what investors’ required rates of return are at each level of risk as measured by the stock's beta. It shows the linear relationship between the beta coefficient for an individual investment and the required rate of return for the investment. However, the slope of a stock's Security Market Line is not the stock's beta, because the possible betas are on the x axis on the graph.
C. Investors require a higher expected return for a stock with a higher beta. The Security Market Line tells us what investors’ required rates of return are at each level of risk as measured by the stock's beta. It shows the linear relationship between the possible beta coefficients for an individual investment and the required rate of return for the investment. On an SML graph, the possible betas are on the x axis, and investors' required rates of return are on the y axis. The slope of a stock's Security Market Line is the market risk premium, which is RM - RF. The graph of the Capital Asset Pricing Model equation is a firm's Security Market Line. Because the required rate of return by investors is a firm's cost of capital, the firm's cost of equity capital will increase as its stock's beta increases. The Security Market Line for an individual stock can be used to estimate the firm's cost of debt capital and equity capital, based on investors’ required rates of return at each level of risk as measured by the stock's beta.
D. The graph of the Capital Asset Pricing Model equation is a firm's Security Market Line. However, the slope of a stock's Security Market Line is not the graphical represenetation of the security's returns.
