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Write out the equation for the CAPM. Using the symbols in the model, identify the expected return on each of three assets: Asset A has a beta of one, Asset B has a beta of zero, and Asset C has a beta of negative one. In each case, interpret your result.
On May 12, 2024
This is a relatively straightforward application of the CAPM, but it does require students to fully understand the implications of the model. Clearly, Asset A is expected to earn the market return while Asset B is expected to earn the risk free rate. Asset C is a little tougher to explain. Students would likely expect that since it has a beta of negative one, it should have an expected return equal to the negative of the market return. However, it is expected to earn 2Rf - E(Rm).