If an asset has a risk-return combination that is above the Security Market Line (SML), then arbitrage will make that asset's:

Question

Quizplus · Accepted Answer

If an asset has a risk-return combination that is above the SML, it means that the asset is providing a higher return than what is expected for its level of risk. This creates an arbitrage opportunity where investors can buy the undervalued/underpriced asset and sell the overvalued/overpriced assets to bring the market back to equilibrium. As a result, the demand for the undervalued asset increases, causing its price to go up and its expected return to decrease. Therefore, the average expected return of the asset will decrease.

If an Asset Has a Risk-Return Combination That Is Above