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Explanation:
Beta identifies the appropriate level of risk for which an investor should be compensated. Unsystematic risk is asset-specific and, therefore, a diversifiable risk. The market risk premium is calculated as the excess of the expected return on the market over the risk-free rate of return. Assets with equivalent betas should earn the same return because arbitrage will prevent assets with the same risk from earning different returns.
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Question 69
Which of the following statements concerning the capital asset pricing model (CAPM) and the security market line (SML) is correct?
A
Beta identifies the appropriate level of risk for which an investor should be compensated.
B
Unsystematic risk is not diversifiable, so there is no reward for taking on such risk.
C
Assets with equivalent betas will always earn different returns.
D
The market risk premium is calculated by multiplying beta by the difference between the expected return on the market and the risk-free rate of return.