If the simple CAPM is valid, which of the following situations are possible? You must provide...

If the simple CAPM is valid, which of the following situations are possible? You must provide an explanation.

Consider each case independently. Your answer should begin with: This is possible or This is not possible because…

For each case, M is the market portfolio and F is the risk-free asset

a	Portfolio	Expected return (%)	Standard deviation(%)
	A	10	15
	B	5	20

b.	Portfolio	Expected return(%)	Beta
	A	10	1.1
	B	9	1.2

c	Portfolio	Expected return(%)	Standard deviation(%)
	A	12	20
	M	12	16
	F	4

Solutions

Expert Solution

a	This is possible, since CAPM is valid. The CAPM return covers only the systematic risk which is presented by the market in the form of Beta which does not include non systematic risk like standard deviation. Hence, Portfolio B's lower rate of return can have higher standard deviation and portfolio A's higher rate of return can have lower standard deviation. However, this would be valid if the beta of B is lower than beta of A

b	This is not possible because the CAPM covers the systematic risk. Therefore a portfolio with higher return will have higher beta that is systematic risk and a portfolio with lower return will have lower Beta.
	Here, portfolio A has higher expected rate of return but lower Beta and Portfolio B has lower rate of return and higher Beta

c	This is possible, As per CAPM the expected return from market should be more than the expected return from portfolio of they have Beta more than 1. Since CAPM does not cover standard deviation and Beta is not known, they can have same return and higher standard deviation for Portfolio A than for market due to various other risk involved

jeff jeffy answered 1 year ago

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