CAPM question with complete solution rated A+ 2023 Verified to pass

CAPM question with complete solution rated A+ 2023 Verified to passWhat is the market risk premium? - correct answer The extra return given/expected by an investor for holding a risky portfolio instead of the risk free rate Represented by the slope of the security market line (SML) What does CAPM stand for? - correct answer Capital Asset Pricing Model What does the Security Market Line (SML) represent - correct answer It is a graphical representation of the CAPM (Beta on the horizontal axis, expected return (Er) on the vertical axis, and the intercept is the risk-free rate) and pinpoints an asset's expected return as predicted by the CAPM for various levels of risk (Beta). If an asset is below the SML, what does this signify? - correct answer This signifies that the asset is overpriced - the asset is earning less returns that predicted by the CAPM, and is therefore an inferior asset and is overpriced. If an asset is above the SML, what does this signify? - correct answer This signifies that the asset is underpriced - the asset is returning more than what the CAPM predicts (superior performance) and is therefore underpriced. What is the term that defines when an asset is plotted above/below the SML, and what does this say about the asset? - correct answer This is called the stock's 'alpha' - if positive, it means the asset is exhibiting superior performance to what the CAPM would predict; if negative, the asset is exhibiting weaker performance compared to what the CAPM would predict. What are the 9 assumptions of the CAPM? - correct answer 1 - There are no transaction costs. 2 - There is no personal income tax. 3 - Assets are infinitely divisible. 4 - Investors make decisions solely based on risk-return 5 - Unlimited short sales