CAPM TRUE or false Flashcards
(17 cards)
A portfolio with a beta of 1 and zero idiosyncratic risk always lies on the Security Market Line.
Yes
In the presence of a risk-free asset, all investors will optimally hold the same market portfolio of risky assets, scaled by their risk preference.
Yes
A portfolio that is mean-variance efficient must lie on the Capital Market Line
No
→ Only portfolios that are combinations of the risk-free asset and the market portfolio lie on the CML
Mean-variance efficiency alone places a portfolio on the efficient frontier of risky assets, which includes points below the CML.
The CAPM assumes that investors maximize utility using expected return and variance only.
Yes
→ CAPM relies on mean-variance preferences (or quadratic utility / normal distributions
Adding a new asset to a portfolio can never shift the efficient frontier to the left.
No
→ If the new asset is not perfectly correlated with existing assets, it may offer better diversification and improve the frontier
If the CAPM holds, then any mispricing must stem from estimation errors, not market inefficiency.
Yes
If an investor holds a tangency portfolio and combines it with borrowing, they always lie on the Security Market Line.
Yes
→ Borrowing or lending at the risk-free rate extends the portfolio along the SML
Roll’s critique implies that empirical tests of the CAPM are only valid if the true market portfolio is observable.
Yes
→ Roll (1977) showed that if we cannot observe the true market portfolio
An investor who prefers assets with negative correlation to consumption is exhibiting risk aversion.
Yes
→ Under CCAPM, such investors prefer assets that hedge consumption drops — this is a core feature of risk aversion.
The existence of a risk-free asset is necessary for the CAPM to determine unique market portfolio weights.
Yes
→ Without a risk-free asset, we get the efficient frontier, but no single tangency portfolio
The market portfolio in CAPM is the only portfolio with the highest Sharpe ratio.
Yes
→ The tangency portfolio
The CAPM assumes that all investors have homogeneous expectations about returns, variances, and covariances.
Yes
→ This is a central CAPM assumption: investors all see the same opportunity set and agree on inputs to mean-variance optimization.
Under CAPM, all assets are priced according to their contribution to portfolio standard deviation.
No
→ Under CAPM, assets are priced according to their contribution to systematic risk (beta)
In the mean-variance framework, an investor’s utility increases with variance.
No
→ Investors are assumed to be risk-averse. Utility increases with expected return, but decreases with variance.
A key assumption of Markowitz portfolio theory is that investors care about skewness in returns.
No
→ Markowitz theory is mean-variance only.
If the correlation between two assets is zero, combining them can never reduce portfolio variance.
No
→ Even with zero correlation, if the assets have different volatilities, diversification can still reduce portfolio variance.
