Capital Asset Market Pricing

Question 1

What does beta measure and when should it be used?

Answer 1

• A measure of comovement of a security or portfolio with the market
• Used when fully diversified

Question 2

What is the capital market line?

Answer 2

A theoretical concept that represents all portfolios that optimally combine the risk-free rate of return and the market portfolio of risky assets.

Question 3

What is the security market line?

Answer 3

The Security Market Line (SML) is a graphical representation of the capital asset pricing model (CAPM), which reflects the linear relationship between a security’s expected return and beta, i.e. its systematic risk.

Question 4

How do you calculate the security market line?

Answer 4

Required return = risk-free rate of return + beta (market return - risk-free rate of return).

Question 5

Due to the definition of portfolio “M” ______________

Answer 5

All diversifiable, unsystematic risk, will be diversified away

Question 6

What is the purpose of the Scholes William Beta?

Answer 6

Adjusts beta for nonsynchronous trading

Question 7

What assumptions can be relaxed about the CAPM?

Answer 7

1) No risk free assets exist, blacks zero beta CAPM
2) Differential lending + Borrowing rates
3) Transaction costs exist
4) Homogeneous expectations

Question 8

What is the zero beta portfolio?

Answer 8

Take assets with 0 comovement within the portfolio and pick the one with the smallest standard deviation

Question 9

Under the relaxed CAPM assumptions, how does the SML plot?

Answer 9

As a band instead of a line

Question 10

How do you calculate portfolio beta?

Answer 10

Portfolio Covariance / Portfolio Variance