Question
Using the SML approach, what is the expected return on a stock if its beta is equal to zero?
Multiple choice question.
The return on the market minus the risk-free rate
The market-risk premium
Zero
The risk-free rate
Multiple choice question.
The return on the market minus the risk-free rate
The market-risk premium
Zero
The risk-free rate
Answers
GPT-4o mini
In the Capital Asset Pricing Model (CAPM), which is closely associated with the Security Market Line (SML) approach, the expected return on a stock can be calculated using the following formula:
\[
\text{Expected Return} = \text{Risk-free rate} + \beta \times (\text{Market return} - \text{Risk-free rate})
\]
If a stock's beta is equal to zero, this means it has no correlation with market movements, and thus the additional risk premium associated with market fluctuations is not applicable to this stock. Therefore, the expected return simplifies to the risk-free rate.
So, the correct answer to the multiple choice question is:
**The risk-free rate**.
\[
\text{Expected Return} = \text{Risk-free rate} + \beta \times (\text{Market return} - \text{Risk-free rate})
\]
If a stock's beta is equal to zero, this means it has no correlation with market movements, and thus the additional risk premium associated with market fluctuations is not applicable to this stock. Therefore, the expected return simplifies to the risk-free rate.
So, the correct answer to the multiple choice question is:
**The risk-free rate**.