TRUE or FALSE 1. A riskless or risk-free asset is presumed to have a return with...

TRUE or FALSE

1. A riskless or risk-free asset is presumed to have a return with zero standard deviation.

2. The portfolio variance of a two-asset portfolio has three terms, two related to the individual underlying assets, and one related to the interaction of the two assets.

3. The CAPM (or SML) model determines the risk-adjusted required rate of return for a stock.

Expert Solution

1. True.

A riskless or riskfree asset is presumed to have a return with zero standard deviation. Standard deviation is considered as a measure of risk in case of assets. If an asset has a standard deviation greater than 0, it is considered as a risky asset. Therefore, an asset with standard deviation equal to 0 is considered as a risk free asset

2. True

The formula for the portfolio variance for two stocks, A and B with weights w(A) and w(B) respectively:

As observable over here, the first term deals with the variance of stock A and its weightage in the overall portfolio.

The second term deals with the variance of the stock B and its weightage in the overall portfolio.

However, the third terms deals with the correlation between the stock A and B and its combined weightage in the portfolio.

3. True

CAPM models states that the expected return on an asset is equivalent to:

Here r(i) is the return on the asset, r(RF) is the risk free rate of return, r(M) is the return of the market, beta is the movement of stock in relation to the market.

So, the overall formula implies that the expected return on the stock is equal to the risk free rate of return plus the market premium for additional risk taken by investing in the stock.

jeff jeffy answered 2 years ago

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