Q14I.
Expert-verifiedIf 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”
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
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