Question

8. Tests of the CAPM The CAPM is one of the most extensively tested models in finance. The following statements describe the assumptions, methods, and findings of several of these studies. Based on your understanding of these issues, which of the following statements are true? Check all that apply. Many studies of the CAPM have used (1) daily or monthly historical returns of the stocks and (2) the rate on both the 30-day U.S. Treasury bill and the long-term U.S. Treasury bond to estimate the risk-free rate (TRF). Two important hypotheses addressed in tests of the CAPM and SML are that (1) a linear relationship exists between the required return on a security and its beta and (2) the intercept on the vertical axis should equal the risk-free rate (PRF). Given its assumptions, the CAPM has greater value as a predictive model than as a conceptual framework for the evaluation of risks and returns. Based on Levy's 1971 examination of the stability of the betas of both individual securities and portfolios of 10 or more randomly selected stocks, it is logical to conclude that the CAPM is a better concept for structuring investment portfolios than for estimating the required return of individual securities.

Answer 1

Yes. The information is accurate. CAPM model suggests that there is a linear relationship between risks and rewards.

Capital Asset Pricing Model Return % Risk premium between 3% and 9% Market return Risk free rate Risk free rate is normally taken as the yield on a long-term government bond in the country where the project/company is based. Risk (market) Beta of the market B = 1