8. The Capital Asset Pricing Model

1. The risk free rate of interest is 10%, the rate of return on the market portfolio is 25% and you hold a portfolio of stocks worth £1000 that has a portfolio beta of 1.5 that is efficiently priced in line with the CAPM. If you borrow £1000 and invest it fully in the portfolio that you currently own then the expected rate of return on your capital is?

32.5% 40.0% 55.0% 65.0%

2. The risk free rate of interest is 4%, the return on the market portfolio is 10% and the standard deviation of the market return is 30%. If a combination of the risk free asset and the market portfolio has a standard deviation of 15%, the beta of the combined portfolio and expected rate of return is:

Beta 0, expected rate of return 6% Beta 0.5, expected rate of return 7% Beta 1, expected rate of return 8% None of the above

3. In determining the required rate of return on a security, the appropriate value of risk is its:

Standard deviation Covariance Correlation coefficient Beta

4. Security A has a beta of 0.5, the risk free rate of interest is 5% and the expected return on the market is 15%. If the security offers a prospective yield of 9% then according to the Capital Asset Pricing Model the security is:

Correctly valued. Undervalued and should be bought. Overvalued and should be sold. On the securities market line.

5. Which of the following is NOT a characteristic of the Securities Market Line?

The standard deviation is on the horizontal axis. It is positively sloped. It intersects the vertical axis at the risk free rate of interest. The slope represents the market price of risk.

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