The basics of the Capital Asset Pricing Model

Which of the following are assumptions of the Capital Asset Pricing Model (CAPM)? Check all that apply.

____There are no taxes.

___Expected returns are based on individual investor risk sensitivity.

___All investors focus on a single holding period.

___Investors have homogeneous expectations.

Consider the equation for the Capital Asset Pricing Model (CAPM):

ri

=

rRF + (rM rRF)

Cov(ri, rM)/2M

Suppose that the markets average excess return on stocks is 12.00% and that the risk-free rate is 2.00%. Complete the following table by computing expected returns to stocks for each beta coefficient using the Capital Asset Pricing Model (CAPM):In this equation, the term rRF represents the ____________ .

bibi	Expected Return to Stocks (%)
0.30
0.50
1.00
5.00

Based on the CAPM and your calculations for the return to stocks, what does it mean when the coefficient bibi = 1?

___The stock is more volatile than the market.

___The stocks return correlates with the stock market as a whole.

___The stock is less volatile than the market.