Suppose the Capital Asset Pricing Model (CAPM) holds, which of the following statements is/are correct? I) All...

Suppose the Capital Asset Pricing Model (CAPM) holds, which of the following statements is/are correct?

I) All securities lie on the capital market line.

II) The risk premium on securities with a negative beta coefficient will be lower than the risk-free rate.

III) The market portfolio is the tangency point between the capital market line and the indifference curve.

IV) The market portfolio lies on the efficient frontier.

Solutions

Expert Solution

IF CAPM holds true then

Expected return of stock = Risk Free Rate + Beta * (Market Return - Risk Free Rate)

Risk Premium of stock = Return of stock - Risk Free Rate

I) All securities lie on the capital market line. - Correct. All the securities will give expected return as per CAPM.

II) The risk premium on securities with a negative beta coefficient will be lower than the risk-free rate. - Incorrect Return will be lower. Risk premium would be negative.

III) The market portfolio is the tangency point between the capital market line and the indifference curve.Incorrect. It is the tangency point between the capital market line and efficient frontier.

IV) The market portfolio lies on the efficient frontier. Correct

jeff jeffy answered 1 year ago

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