CAPM

The opportunity line is the:

• set of investment opportunities made available by mixing two risky assets.

• set of all portfolios with the same expected rate of return but different standard deviations.

• set of investment opportunities made available by mixing a risky asset and a risk-free asset.

• set of portfolios among which the investor is indifferent.

Consider a graph with standard deviation on the horizontal axis and expected return on the vertical axis. The line that connects the risk-free rate and the optimal risky portfolio is called:

• the security market line.

• the characteristic line.

• the capital market line.

• the indifference curve.

Market risk is also called:

• nondiversifiable risk and systematic risk.

• unique risk and nondiversifiable risk.

• systematic risk and diversifiable risk.

• systematic risk and unique risk.

If an asset’s expected return plots above the security market line, the asset is:

• under priced.

• overpriced.

• fairly priced (if it has an unusually large amount of unique risk).

• Depends on the Market Premium

Capital asset pricing theory asserts that portfolio returns are best explained by:

• diversification.

• systematic risk.

• economic factors.

• specific risk.

The market portfolio has a beta of:

• 2.0

• 0.0

• 1.0

• –1.0

The risk-free rate for the next year is 3%, and the market risk premium is expected to be 10%. The beta of Acme’s stock is 1.5. If you believe that Acme’s stock will actually return 18.2% over the next year, then according to the CAPM you should:

• sell the stock because it is under priced.

• sell the stock because it is overpriced.

• buy the stock because it is overpriced.

• buy the stock because it is under priced.

Stock A has a beta of 1.0 and very high unique risk. If the expected return on the market is 20%, then according to the CAPM the expected return on Stock A will be:

• exactly 20%.

• the answer cannot be found without knowing Stock A’s correlation or covariance with the market.

• at least 20% if the investor holds only Stock A.

• more than 20% because of Stock A’s very high unique risk.

Stock A and Stock B are combined into an equally weighted portfolio. If Stock A has a standard deviation of return of 30%, Stock B has a standard deviation of return of 30%, and the portfolio of the two stocks has a standard deviation of return of 30%, what is the correlation coefficient of the returns between the two stocks?

• 0.0

• 1.0

• -1.0

• 2.0

The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to

• 0.06

• 0.144

• 0.12

• 0.132