Question

In a simple CAPM world which of the following statements is (are) correct?

I. All investors will choose to hold the portfolio which includes all riskless assets in the world.

II. Investors will choose the same portfolio even if their levels of risk aversion are different.

III. The return per unit of risk will be different for different individual assets.

IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.

Multiple Choice

I and III only

I and IV only

IV only I,

II, III, and IV

Answer 1

Here the correct answer is only IV.

^{In CAPM model all investors will choose to hold the market portfolio, which includes all risky assets in the world beacuse risky assets will give high returns. Investors' complete portfolio will vary depending on their risk aversion and the return per unit of risk will be different for different individual assets. So that the 1,2, and 3 statements are wrong. Here the correct statement about CAPM model is the market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.}

^{The efficient frontier is the set of optimal portfolios which gives  highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios lie below the efficient frontier does not provide enough return for the level of risk so that they are sub-optimal. Portfolios that lie above or cluster to the right of the efficient frontier are sub-optimal and  they will give a higher level of return for the defined rate of risk. The CAPM model describes the relationship between systematic risk and expected return for assets so  the market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.}