Question

2. You are interested in investing in stock F. You estimate its beta using data on the past returns of the stock, of the market portfolio, and of the risk-free interest rate. After computing the expected rate of return using the CAPM formula, you find that the stock has generated positive alphas over the last month. Find at least two reasons for this that do not put the assumptions of CAPM into question, i.e., that do not involve strong market efficiency, mean-variance preferences, or complete markets (6 lines max). (5 points)

Answer 1

When I have done the expected rate of return calculation using the Capital Asset pricing model and if I have found out that the company is generating the alphas over the past two months, two reasons for this that do not put the assumption of Capital Asset pricing model into question-

A. All investors will be aiming to maximize the economic utilities and it will be done in order to maximize the overall rate of return

B. markets will be highly liquid and there will be no restrictions on selling of the securities and it can be sold once it is found to be overpriced.