2: CAPM

Question 1

4 individual assumptions of CAPM

Answer 1

1. Same time horizon.
2. Anyone can borrow/lend at rf.
3. Info avail to all investors.
4. Investors are rational and have quad utility fnc.

Question 2

Market assumptions of CAPM (3)

Answer 2

1. No individual can influence prices
2. Large no of each asset.
3. No friction (trans costs or taxes).

Question 3

CAPM assumptions that fail irl

Answer 3

• Not everyone can borrow at the same rate
• Info is not available to everyone
• Taxes and transaction costs are common

Question 4

What is the CML?

Answer 4

Essentially the efficient frontier formed from mixing the risk-free asset with the tangency portfolio.

Question 5

What does the CML look at?

Answer 5

The return vs risk of efficient portfolios.

Question 6

What does SML show?

Answer 6

The SML shows the relationship between return and systematic risk, so it is applicable to all assets whether they are efficient or not.

Question 7

In an efficient portfolio,
Beta =

Answer 7

βz= σz / σm

Question 8

What is certainty equivilant form of the CAPM formula

Answer 8

Some shit related to discounting the FV

Question 9

What is individual optimization

Answer 9

the desire for an investor to maximise U(mean,variance)

Question 10

What does the CML show

Answer 10

a straight line of efficient portfolios

Question 11

CML equation

Answer 11

Question 12

Sharpe ratio

Answer 12

Question 13

Correlation and covariance linking equation

Answer 13

Question 14

Notable advantage of factor models over CAPM

Answer 14

Less parameters to estimate

Question 15

How do we price assets using CAPM?

Answer 15

Use certainty equiv formula