Explain the Implications of the CAPM. Explain the Security Market Line (SML). Explain the Two-Factor...

Explain the Implications of the CAPM.

Explain the Security Market Line (SML).

Explain the Two-Factor model by Merton.

Solutions

Expert Solution

Solution:-

Implication of CAPM

1.Risk tolerent investors will use most of their wealth in risky assets

2.Tangency portfolio=Market Port folio

3.Market Portfolio is mean-varience efficient

4.SML Pricing holds for all assets and portfolio

Security Market Line(SML)

Security market line is the graphical representation of Capital Asset Pricing Model(CAPM).SML will hepls the investors to know that the investment offer favourable expected return .Security market line (SML) generally used to compare between two investment whether which investment offers best and favourable return at a specified level of risk.

Formula for calculating SML is as below;-

Risk free rate of return+Beta(Market return-Risk free rate of return)

We can check whether the investment is favourable or not as per tha following

1) if the security spoted on SML chart is above thae SML line is considered that the security offers a greater return.

2)if the security spoted on SML chart is below the SML line is considered that over valued price becuase the expected return is not favourable

jeff jeffy answered 1 year ago

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