If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
The correct answer would be: “Possible”
The CAPM or the Capital Asset Pricing Model helps in establishing a fair value of stock in comparison to the stock’s current market value.
If the CAPM is valid, the expected rate of return compensates only for systematic (market) risk as measured by beta, rather than the standard deviation, which includes non-systematic risk. Thus, in the above scenario, Portfolio A's lower expected rate of return can be paired with a higher standard deviation, as long as Portfolio A's beta is lower than that of Portfolio B.
Therefore this is not possible
Which of the following sources of market inefficiency would be most easily exploited?
a. A stock price drops suddenly due to a large block sale by an institution.
b. A stock is overpriced because traders are restricted from short sales.
c. Stocks are overvalued because investors are exuberant over increased productivity in the economy.
a. Briefly explain the concept of the efficient market hypothesis (EMH) and each of its three forms—weak, semi-strong, and strong—and briefly discuss the degree to which existing empirical evidence supports each of the three forms of the EMH.
b. Briefly discuss the implications of the efficient market hypothesis for investment policy as it applies to:
i. Technical analysis in the form of charting.
ii. Fundamental analysis.
c. Briefly explain the roles or responsibilities of portfolio managers in an efficient market environment.
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