Question

Which of the following are assumptions of the Capital Asset Pricing Model (CAPM)? Check all that apply.

• Investors assume that their investment activities won't affect the price of a stock.

• There are no taxes.

• Assets won't be short sold.

• Asset quantities aren't given.

Consider the equation for the Capital Asset Pricing Model (CAPM):

$$ \hat{r}_{1}=r_{R F}+\left(\hat{r}_{M}-r_{R F}\right) \times \frac{\operatorname{Cov}\left(r_{i}, r_{M}\right)}{\sigma_{M}^{2}} $$

In this equation, the term \(r_{R F}\) represents the

rate of return on a risk-free bond

Suppose that the market's average excess return on stocks is 6.00 % and that the risk-free rate is 2.00 %. Complete the following table by computing expected returns to stocks for each beta coefficient using the Capital Asset Pricing Model (CAPM):

Based on the CAPM and your calculations for the return to stocks, what does it mean when the coefficient b <0 ?

• The stock's price moves in the opposite direction of the market as a whole.

• The stock has more systematic risk than one with a larger beta.

• The stock has less systematic risk than one with a larger beta.

Answer 1

Answer 1: Assumptions that are true are the first 3 from the options

• Markets are ideal—no transaction fees, taxes, inflation, or short selling restrictions.
• The amount of available assets is fixed during a given period of time.
• Markets are in equilibrium. All investors are price takers, not price makers as there are many small investors who cannot influence the price.

Answer 2: With Bi < 0 - The stock's price moves in the opposite direction of the market as a whole is the correct answer, please refer to the attached image for a detailed explanation

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