Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

V. Risk and Return 13. Return, Risk, and the

Security Market Line

(^464) © The McGraw−Hill
Companies, 2002
E(RP) .25 E(RB) (1
.25) Rf
.25 16% .75 8%
10%
Similarly, the beta on the portfolio, (^) P, would be:
(^) P.25 
B(1
.25)  0
.25 1.2
.30
Some other possibilities are as follows:
When we plot these combinations of portfolio expected returns and portfolio betas in
Figure 13.2B, we get a straight line just as we did for Asset A.
The key thing to notice is that when we compare the results for Assets A and B, as in
Figure 13.2C, the line describing the combinations of expected returns and betas for As-
set A is higher than the one for Asset B. What this tells us is that for any given level of
systematic risk (as measured by ), some combination of Asset A and the risk-free asset
always offers a larger return. This is why we were able to state that Asset A is a better
investment than Asset B.
Percentage of Portfolio Portfolio Portfolio
in Asset B Expected Return Beta
0% 8% .0
25 10 .3
50 12 .6
75 14 .9
100 16 1.2
125 18 1.5
150 20 1.8
436 PART FIVE Risk and Return

FIGURE 13.2B

Portfolio bet

(

Portfolio expected

return (E(RP))

E(RB) = 16%

1.2 =

Rf = 8%

E (RB) – Rf

= = 6.67%

(^) B
(^) B
a
(^) P)
Portfolio Expected Returns and Betas for Asset B