CAPM Flashcards
What are the four assumptions of CAPM?
All investors choose their optimal portfolios solely on the basis of the mean-variance criterion.
There is a risk-free rate at which an investor may lend or borrow. The risk-free rate is the same for all investors.
All investors have the same planning horizon for their respective investment plans and agree on the distributions of security returns over this horizon.
The market for capital is perfect.
o There are no transaction costs associated with buying or selling securities.
o There are no taxes on dividends, interest income, and capital gains.
o Assets are infinitely divisible.
o All information about the possible returns of any security is freely available to everyone.
o There are no restrictions on short-selling.
o Markets are perfectly competitive: i.e. the number of buyers and sellers is sufficient large, and all investors are small enough to relative to the market, so that no individual investor can influence assets’ prices
- How can we tell if securities are under or overvalued by using the security market line?
If they lie above the SML they are undervalued and vice versa
You expect the stock market to go up by 10% over the next year. The standard deviation of the market return is 20%. You can buy 1 year government bonds yielding 4%. If you have $100,000 to invest and you are willing to tolerate a risk (standard deviation) of 15%, what is the best allocation of your money? How much money do you expect to have one year from now?
