8 Moving towards the Capital Asset Pricing Model

Question 1

What is the time value of money

Answer 1

This represents the risk free rate of return you are giving up by selecting another investment

Question 2

How do you move from the efficiency frontier to the CML

Answer 2

By finding the most efficient portfolio (M, top left) and then lending or borrowing at the risk free rate

Question 3

What is M

Answer 3

Market portfolio
All risky investments
All investors own M
Unlike portfolio theory which suggests 10-15 CAPM suggests 1000’s to get as close to M as possible

Question 4

What are indifference curves

Answer 4

They come in sets where the individual would get equal utility
Always want to move north-west

Question 5

Assumptions in CAPM

Answer 5

1. Investors base decisions only on risk and return (rational)
2. Investors have same estimations for risk and return
3. Perfect capital markets
4. Investors cannot influence price of asset
5. Supply of asset is fixed

Question 6

Problems with CAPM

Answer 6

1. Assumes no taxes or transaction costs
2. Investors are able to borrow at risk free rate