AIMs: Understand the derivation and components of the CAPM. Describe the assumptions underlying the CAPM.
Questions:
60.1. Roger is an analyst employing the Sharpe-Lintner-Mossin capital asset pricing model (CAPM) to estimate the return of a portfolio. However, his colleague Sally makes four observations. If true, each observation violates an assumption of this standard version of the CAPM. Which of the following observations, if true, does NOT violate an assumption such that, by itself, is consistent with the CAPM; i.e., each of the following is a standard CAPM assumptional violation EXCEPT?
a. Sally proves that the portfolio securities' returns are heavy-tailed (leptokurtic)
b. Sally observes that other investors have different views about the expected returns and variances of the portfolio securities
c. If Roger makes a purchase of a security in the portfolio, his purchase will NOT increase (or impact) the price of the security
d. Sally points out that Roger incurs transaction costs, cannot short sell, and cannot borrow at the risk-rate
60.2. In regard to the derivation of the Sharpe-Lintner-Mossin capital asset pricing model (CAPM), each of the following is true EXCEPT for:
a. All investors will hold combinations of only two portfolios: the Market portfolio ( M) and a Riskless security. This is called the "two mutual fund theorem" because all investors would be satisfied with a market fund, plus the ability to lend or borrow a riskless security
b. All portfolios and risky assets must lie along (on) the capital market line (CML)
c. In equilibrium, the Market portfolio lies at the tangency point between the original efficient frontier of risky assets and a straight line ("ray") passing through the riskless return
d. The security market line (SML) implies: the relationship between the expected return on any two assets can be related simply to their difference in Beta; the higher Beta is for any security, the higher must be its equilibrium return; and the relationship between Beta and expected return is linear
60.3. Which of the following is strictly true about the standard (Sharpe-Lintner-Mossin) version of the capital asset pricing model (CAPM)?
a. The security market line (SML) states that the expected return on any security is the riskless rate of interest plus the market price of risk times the amount of risk in the security or portfolio
b. If CAPM is valid, then the return of a high-beta should be higher than the return of a low-beta stock over the next calendar year, or for that matter, any given calendar year
c. All other things being equal, the security market line (SML) implies that higher non-systematic (aka, idiosyncratic) risk will produce higher expected returns
d. While CAPM characterizes equilibrium in terms of rate of return, it cannot be similarly extended to prices
Answers:
Questions:
60.1. Roger is an analyst employing the Sharpe-Lintner-Mossin capital asset pricing model (CAPM) to estimate the return of a portfolio. However, his colleague Sally makes four observations. If true, each observation violates an assumption of this standard version of the CAPM. Which of the following observations, if true, does NOT violate an assumption such that, by itself, is consistent with the CAPM; i.e., each of the following is a standard CAPM assumptional violation EXCEPT?
a. Sally proves that the portfolio securities' returns are heavy-tailed (leptokurtic)
b. Sally observes that other investors have different views about the expected returns and variances of the portfolio securities
c. If Roger makes a purchase of a security in the portfolio, his purchase will NOT increase (or impact) the price of the security
d. Sally points out that Roger incurs transaction costs, cannot short sell, and cannot borrow at the risk-rate
60.2. In regard to the derivation of the Sharpe-Lintner-Mossin capital asset pricing model (CAPM), each of the following is true EXCEPT for:
a. All investors will hold combinations of only two portfolios: the Market portfolio ( M) and a Riskless security. This is called the "two mutual fund theorem" because all investors would be satisfied with a market fund, plus the ability to lend or borrow a riskless security
b. All portfolios and risky assets must lie along (on) the capital market line (CML)
c. In equilibrium, the Market portfolio lies at the tangency point between the original efficient frontier of risky assets and a straight line ("ray") passing through the riskless return
d. The security market line (SML) implies: the relationship between the expected return on any two assets can be related simply to their difference in Beta; the higher Beta is for any security, the higher must be its equilibrium return; and the relationship between Beta and expected return is linear
60.3. Which of the following is strictly true about the standard (Sharpe-Lintner-Mossin) version of the capital asset pricing model (CAPM)?
a. The security market line (SML) states that the expected return on any security is the riskless rate of interest plus the market price of risk times the amount of risk in the security or portfolio
b. If CAPM is valid, then the return of a high-beta should be higher than the return of a low-beta stock over the next calendar year, or for that matter, any given calendar year
c. All other things being equal, the security market line (SML) implies that higher non-systematic (aka, idiosyncratic) risk will produce higher expected returns
d. While CAPM characterizes equilibrium in terms of rate of return, it cannot be similarly extended to prices
Answers: