Question

If stock prices follow a random walk, future stock prices are easy to predict. (true or false explain)

The CAPM tells us that any person who seeks a large expected return must be willing to assume proportionately greater total risk(true or false explain)

Answer 1

1. FALSE

Random walk theory as the name suggest this theory advocate that the stock price movement are random, it is not related previous price, it has no price movement trends. Thus, if stock price follow a random walk then prediction of future price of stock is impossible because it is not related to its previous price.

2. FALSE

Total risk can be sub-divided to two parts - systematic risk (non diversifiable) and unsystematic risk (diversifiable). The Capital Assets Pricing Model assume that a stock's unsystematic can be avoided by adding it to well diversified portfolio.Thus, CAPM only consider the systematic risk i.e also called Beta. CAPM tells us that if a person seeks large expected return must be willing to assume greater systematic risk (Beta, price sensitivity to market).

CAPM does not consider the total risk of the stock.