Capital Asset Pricing Model-

a. What is the capital asset pricing model (CAPM)? What are the assumptions that underlie the model?

1. Carefully explain the meaning of beta. Use three graphs in your explanation to illustrate your answer.
2. Construct a reasonable, but hypothetical, graph which shows risk, as measured by portfolio standard deviation, on the x axis and expected rate of return on the y axis. Now add an illustrative feasible (or attainable) set of portfolios, and show what portion of the feasible set is efficient. What makes a particular portfolio efficient? Don't worry about specific values when constructing the graphmerely illustrate how things look with "reasonable" data.
3. Now add the risk-free asset. What impact does this have on the efficient frontier?
4. Explain the idea behind the capital market line. Write out the equation for the capital market line (CML) and draw it on the graph. Interpret the CML. Explain how an investor's optimal portfolio is some combination of the risky portfolio and the risk-free asset. What is the composition of the risky portfolio? Why do the different investors choose different portfolios? How does risk preference effect where they will choose to be.