Question

State whether each of the following is inconsistent with an efficient capital? market, the? CAPM, or? both:

a. A security with only diversifiable risk has an expected return that exceeds the? risk-free interest rate.

b. A security with a beta of 1 had a return last year of? 15% when the market had a return of? 9%.

c. Small stocks with betas of 1.5 tend to have higher returns on average than large stocks with betas of 1.5.??

a. A security with only diversifiable risk has an expected return that exceeds the? risk-free interest rate. ? (Select the best choice? below.)

A. The statement is inconsistent with the CAPM but not necessarily with an efficient capital market.

B. The statement is inconsistent with both the CAPM and an efficient capital market.

C. The statement is consistent with both the CAPM and an efficient capital market.

D. The statement is inconsistent with an efficient capital market but not necessarily with the CAPM.

b. A security with a beta of 1 had a return last year of? 15% when the market had a return of? 9%. ? (Select the best choice? below.)

A. The statement is inconsistent with both the CAPM and an efficient capital market.

B. The statement is inconsistent with the CAPM but not necessarily with an efficient capital market.

C. The statement is consistent with both the CAPM and an efficient capital market.

D. The statement is inconsistent with an efficient capital market but not necessarily with the CAPM.

c. Small stocks with betas of 1.5 tend to have higher returns on average than large stocks with betas of 1.5. ? (Select the best choice? below.)

A. The statement is inconsistent with the CAPM but not necessarily with an efficient capital market.

B. The statement is inconsistent with both the CAPM and an efficient capital market.

C. The statement is inconsistent with an efficient capital market but not necessarily with the CAPM.

D. The statement is consistent with both the CAPM and an efficient capital market.

Answer 1

Ans :

a) The statement is inconsistent with both the CAPM and efficient capital market, as both are actually considering the non -diversified risjk, beta. Option B is correct.

b) This statement is consistent with both CAPM and efficient capital market, as for beta= non diversfiable risk =1 the security should have same return as market, but due to diversifiable risk it can have more return. Option C is correct.

c) This statement can be consistent with efficient market portfolio in one of the instances but inconsistent with CAPM, as CAPM precisely states that for same beta the return is same for any stock , small or large stocks.

Option A is correct.