Answer the following question about beta and CAPM and explain why. a. If the CAPM holds...

Answer the following question about beta and CAPM and explain why.

a. If the CAPM holds (market portfolio could be used to compute betas for specific projects/firms), it does not matter whether you invest in one stock or in a portfolio of stocks. All stocks are fairly priced (markets are efficient) and you will receive the appropriate compensation for the risks that you bear. True or false?

b. Suppose the CAPM holds. If two stocks have the same correlation with the market portfolio, then they must have the same beta. True or false?

c. Stock A has an expected return that is higher than the expected return on the market portfolio. Is this sentence consistent with the CAPM?

d. The optimal portfolio for an individual investor has a short position (i.e., a negative portfolio weight) in Stock D. Is this sentence consistent with the CAPM?

e. Stock E has a beta of 1.2 with the market portfolio. In a specific year, the market portfolio had a return of 17.9%. Stock E had a return of 14.1% over the same year. Is this sentence consistent with the CAPM?

Solutions

Expert Solution

a.True

if the CAPM holds ,it does not matter whether you invest in one stock or in a portfolio of stocks.All stocks are fairly priced and you will receive the appropriate copensation for the risks you bear -this sentence is correct as it does not matter how much you diversify your investments some level of risk out of those investments or portfolio of investments will always exist.

b.False.

If the two stocks have the same correlation with the market portfolio, then they must have same beta this sentence is not correct as same correlation does not mean same beta as beta will also depend upon the standard deviation(risk) of the stocks.Different stocks may have different standard deviation.

c.stock a has an expected return that is higher than the expected return on market portfolio leads to underpricing.

d.The optimal portfolio for an investor hasshort position in stock d -yes the sentence is consistent with CAPM as in capm optimal portfolio for an individdual investor only can have short position

e.yes the sentence is consistent with capm as it will lead to overpricing of stocks.

jeff jeffy answered 2 years ago

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