Question

6) Assume a fictitious world where there are four stocks:

General Electric (GE)

CitiGroup (C)

British Petroleum (BP)

FaceBook (FB)

The market is in equilibrium where CAPM assumptions hold (e.g. homogeneous expectations, efficient markets, zero transaction costs, etc.)

Describe in words, the equilibrium relationship

Answer 1

When there would be an equilibrium relationship, then there would be true reflection of the prices of various stocks and there would not be involvement of any kind of fraud and there would be complete rationality on the part of the investors in the decision-making and they would be assuming efficient rate of return on all these companies and they would be consisting a portfolios which would be already diversified and they would not be having much risk in the market.

the equilibrium relationship will also be reflecting that there should be appropriate adjustment of the portfolio according to the changing conditions without the much intervention of the investor and the passive management of the portfolio would be done and after the investor has invested into these four stocks into an equilibrium then the return would also be consistent in nature throughout and they are not be subject to any kind of fluctuations and market risk.