(1) CAPM predicts that the risk premium increase in proportion to the beta of a security. Justify this statement using Figures 10.6 and 10.7 in Chapter 10.

Figure 10.6 The Historical Tradeoff Between Risk and Return in Large Portfolios 25% obec Small Stocks 20% - Mid-Cap Stocks 15% S&P 500 Historical Average Return 10% Corporate Bonds World Portfolio 8.6% historical excess return of S&P 500 over TBills 5% % Treasury Bills om 309 359 45. 50% Historical Volatility (standard deviation) Note the general increasing relationship between historical volatility and average return for these large portfolios. In addition to the portfolios in Figure 10.1 also included is a mid-cap portfolio composed of the 10% of U.S. stocks those size is just above the median of all us, stocks. ( Data 10.SANA Figure 10.7 Historical Volatility and Return of the 500 Largest Individual Stocks 25% A = stocks 1-50 = stocks 51-400 o = stocks 401-500 Small Stocks 20% Mid-Cap Stocks 15% S&P 500 Historical Average Return 10% E Corporate Bonds World Portfolio Treasury Bilis 10% 15% 209 25% 30% 35% 40% 45% Historical Volatility (standard deviation) Each point represents the volatility and average return of investing in the Nth largest stock traded in the United States (updated annually). Unlike the case for large portfollos, there is no precise