Question

Are the following true or false? Explain.

a. Stocks with a beta of zero offer an expected rate of return of zero.

b. The CAPM implies that investors require a higher return to hold highly volatile securities.

c. You can construct a portfolio with beta of .75 by investing .75 of the investment budget in T-bills and the remainder in the market portfolio.

Short answer

Option ‘a’, ‘b’ and ‘c’ are ‘False’.

Step-by-step solution

Solution for ‘a’

β= 0 implies E(r) = r_f, not zero.

Therefore the correct answer for option ‘a’ is False.

Solution for ‘b’

Since Investors require a risk premium for bearing systematic risk (i.e., market or

Un-diversifiable) therefore the correct answer for option ‘b’ is False.

Solution for ‘c’

You should invest 0.75 of your portfolio in the market portfolio, and the remainder in T-bills.

Then:β_P = (0.75 x 1) + (0.25 x 0) = 0.75

Therefore the correct answer for option ‘c’ is False.