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Q14I.

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Essentials Of Investments
Found in: Page 226
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.

Portfolio

Expected Return

Standard Deviation

A

B

30%

40

35%

25

The correct answer would be: “Possible”

See the step by step solution

Step by Step Solution

Step 1: Given Information

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.

Step 2: Solution

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

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