Question

1. Explain the components of the single index model, linking diversifiable and systematic risk to your answer.
2. What is the Security Characteristic Line and what information does it convey?

Answer 1

Q. 2). Answer :- Security Characteristic line (SCL):-

Capital asset pricing model (CAPM) describes the linear relationship between risk-return trade-off for the securities / portfolios. CAPM method distinguishes between risk of holding a single asset and holding a portfolio of assets. There is a trade-off between risk and return. A graphical representation of CAPM method is the Security Characteristic Line, (SCL), which indicates the rate of return required to compensate at a given level of risk.

Security Characteristic Line, (SCL) provides information for evaluating any investment decision where the capital is committed with a goal of producing the future returns. It is developed with the main goal to formulate the return required by investors from a single investment or a portfolio of assets. The required rate of return is defined as the minimum expected return needed so that investors will purchase and hold an asset.