(a) The CAPM assumes that investors have homogeneous expectations. Explain what this assumption means and discuss its implications to investors. The CAPM assumes that investors has homogeneous expectation which assumption assumes all investors analyze securities, in the same way using the same probability distributions and inputs for future cash flows. In addition it means that all asset valuations are identical and the same optimal portfolio of risky assets is generated which we learned is market portfolio. This assumption can be relied on as long as the generated optimal risky portfolios are not significantly different. Based on the definition, its implication for investors is, if investors are shown several investment plans with different returns at a particular risk, they will choose the plan that boasts the highest return. Alternatively, if investors are shown plans that have different risks but the same returns, they will choose the plan that has the lowest risk. (b) Explain what the separation/mutual fund theorem is, and discuss its importance to (i) investors and (ii) portfolio/asset managers. Nobel laureate, James Tobin proposed mutual fund separation theorem also known as mutual fund theorem. Based on what we learned in class, mutual fund separation theorem states that any investor's optimal portfolio can be constructed by holding each of certain mutual funds in appropriate ratios. In this case, the number of mutual funds is smaller than the number of individual assets in the portfolio. Here a mutual fund refers to any specified benchmark portfolio of the available assets. It is important to investors because investor can contrast its optimal portfolio holding each of certain mutual funds in appropriate ratios. If an investor fulfills the given requirements, it may be easier for him/her to purchase a smaller number of mutual funds than to purchase a larger number of assets individually. It helps portfolio/assets manager to make investment and financing decision