186 Financial Management Asindicated in Figure-10, for an investment of zero risk the required return is not zero. Investor will require compansation for the passage of time, because the risk~ free alternatives are available which offer such a retum. The required return compensates the investor for the passage of time and the riskiness of the investment. Thus, the required rate of return is equal to the risk-free rate plus a risk premium. Required Rates of Return in the Market ‘A major function of financial markets is to establish prices. Given risk-averse investors, different rates are established for different degrees of risk. The relevant perspective now becomes that of all investors who are actively involved in buying and selling securities. A risk return line may be identified that reflects their attitudes regarding the minimum acceptable rate of return for a given level or risk. One possible description of this relationship, the security market line (SML), is represented graphically in Figure-11. Although the risk-return relationship in the market (SML) is similar in meaning to individual's risk-return preferences, the SML provides an extra dimension. Since the SML results from actual market transactions (buying and selling), the relationship represents not only the risk-return demands of investors in the market, but also the investor's opportunity set. The term opportunity set is used to indicate that this risk-return relationship is actually available for an investor interested in purchasing or selling securities. FIGURE SECURITY MARKET LINE Risk Premium i 3 ‘Market Risk