Question

State whether each of the following is inconsistent with an efficient capital? market, the? CAPM, or? both: a. A security with only diversifiable risk has an expected return that exceeds the? risk-free interest rate. b. A security with a beta of 1 had a return last year of? 15% when the market had a return of? 9%. c. Small stocks with betas of 1.5 tend to have higher returns on average than large stocks with betas of 1.5.??

Answer 1

State whether each of the following is inconsistent with an efficient capital? market, the? CAPM, or? both:

a. A security with only diversifiable risk has an expected return that exceeds the? risk-free interest rate.

Comment: This statement is not consistent with either of the model. Return is based on market risk or systematic risk.

b. A security with a beta of 1 had a return last year of? 15% when the market had a return of? 9%.

Comment: This is consistent with both of the model or approaches. Efficient market theory says return depends on its risk. In CAPM there can be possibility that unsystematic risk influences the actual return of the security.

c. Small stocks with betas of 1.5 tend to have higher returns on average than large stocks with betas of 1.5.??

Comment: CAPM does not differentiate the large and small stock hence this is inconsistent with CAPM. Statement is consistent with efficient capital market.