Under the CAPM, all investors form portfolios of two assets, a risk-free asset and a risky portfolio M, regardless of their level of wealth Y. If an investor becomes wealthier, he may want to increase or decrease the proportion of his wealth held in the risky portfolio, and, by the Cass-Stiglitz Theorem, unless his preferences have a very specific form, as his wealth changes, he will want to alter the composition of the risky part of his portfolio. The CAPM does not assume such preference restrictions. Yet, the CAPM equilibrium does not seem to permit the desired changes in the composition of the agent's risky portfolio! Is there a contradiction?

Under the CAPM, all investors form portfolios of two assets, a risk-free asset and a risky portfolio M, regardless of their level of wealth Y. If an investor becomes wealthier, he may want to increase or decrease the proportion of his wealth held in the risky portfolio, and, by the Cass-Stiglitz Theorem, unless his preferences have a very specific form, as his wealth changes, he will want to alter the composition of the risky part of his portfolio. The CAPM does not assume such preference restrictions. Yet, the CAPM equilibrium does not seem to permit the desired changes in the composition of the agent's risky portfolio! Is there a contradiction?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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In order to benefit from diversification, the returns on assets in a portfolio must: Answer a. Not be perfectly positively correlated b. Have the same idiosyncratic risks c. Be perfectly positively correlated d. Be perfectly negatively correlated
An increase in investor risk aversion would be expected to: Increase the Risk-Free Rate while Decreasing the Expected Return on the Market Portfolio. Increase the Risk-Free Rate while Increasing the Expected Return on the Market Portfolio. Decrease the Risk-Free Rate while Decreasing the Expected Return on the Market Portfolio. Decrease the Risk-Free Rate while Increasing the Expected Return on the Market Portfolio. There is not enough information to determine how the Risk-Free Rate and Expected Return on the Market Portfolio will change. None of the above answers is correct.
The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in: A. the capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. B. the capital market line which shows that all investors will only invest in the riskless asset. C. the security market line which shows that all investors will invest in the riskless asset only. D. the security market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. E. None of these.
Regarding the Security Market Line (SML) and the Capital Asset Pricing Model (CAPM): If the expected return is less than the required return estimated with the CAPM, the expected return will plot below the SML and the asset is considered to be overpriced If the expected return is greater than the required return estimated with the CAPM, the expected return will plot above the SML and the asset is considered to be underpriced If the expected return is greater than the required return estimated with the CAPM, the expected return will plot below the SML and the asset is considered to be overpriced If the expected return is less than the required return estimated with the CAPM, the expected return will plot above the SML and the asset is considered to be underpriced
Mutual funds offer investors a.a lower return for less risk than what the investor could earn on his own. b.a lower return for more risk than what the investor could earn on his own. c.a way for individuals to eliminate the idiosyncratic risk associated with any single investment. d.a greater return for greater risk than what an investor can earn on his own.
Ted believes that he currently owns a portfolio which is adequately diversified. If he is correct, the addition of a a. risky; rate of return b. risky; beta c. risk-free; beta d. risky; standard deviation e. risk - free; rate of return asset to the portfolio will have minimal, if any, effect on the portfolio's
Suppose the financial institution is trying to minimise their exposure to changes in the underlying asset price. Explain why the financial institution may want to keep their portfolio both Delta and Gamma neutral
In a seminal article on portfolio theory, Markowitz (1952) illustrated that investors are not compensated for taking on firm specific or idiosyncratic risk; however, they are compensated for taking market or systemic risk. Use your understanding of the Capital Asset Pricing Model (CAPM), statistical concepts such as standard deviation and variance, and our ideas about market efficiency and indicate whether you believe that this is a good theory. Include at least two citations that support your response.
If you decided to hold a one- stock portfolio and consequently were exposed to more risk than diversified investors, could you expect to be compensated for all of your risk; that is, could you earn a risk premium on that part of your risk that you could have eliminated by diversifying?
2. Stock prices and stand-alone risk Risk is the potential for an investment to generate more than one return. A security that will produce only one known return is referred to as a risk-free asset, as there is no potential for deviation from the known expected outcome. Investments that have the chance of producing more than one possible outcome are called risky assets. Risk, or potential variability in an investment's possible returns, occurs when there is uncertainty about an investment's future outcome, such as the return expected to be generated by the investment and realized by an investor. Generally, investors would prefer to invest in assets that have: O A higher-than-average expected rate of return given the perceived risk O A lower-than-average expected rate of return given the perceived risk Read the following descriptions and identify the type of risk or term being described: Description This type of risk relates to the possibility that a firm will not be able to service its…
From the sentences below, choose the one that DOES NOT fit in the concept of diversification. * An investor should investment her/his money in different types of securites because by doing so she/he will be able to create a compensation effect in which the less good performance of some investments can be compensated by the good performance of other investments. A portfolio constructed of different kinds of investments will, on average, have higher returns and a lower risk than any individual investment found within the portfolio. A very well diversified portfolio should be composed by different types of securities, from different sectors and from different geographical locations. Do not put all your eggs in one basket. In order to have the maximum return, an investor should invest all her/his money in the top 5 best stocks of the market.
Which is least likely correct about security valuation?a. The calculated or determined value considers the stream of future cash flows.b. The calculated or determined value equals the market price.c. The calculated or determined value considers the risks involved and the opportunity cost.d. The calculated or determined value allows the investors to evaluate whether a security isovervalued or undervalued.e. All of the above

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