With regards to the capital asset pricing model, relaxing assumptions about: A) taxes will reduce differences between the capital market lines of different investors. B) transaction costs will make investors more likely to sell, and less likely to hold. C) homogeneous expectations will result in the SML appearing more as a band instead of a line. D) risk free borrowing and lending rates results in a lower intercept and steeper slope.
A would increase differences B doesn’t make sense to me C I think this is correct D no idea I’m going with C.
C?
I would say C… Edit…
I would guess C, but since it is on AF it is probably wrong. My reasoning is below: thepinkman Wrote: ------------------------------------------------------- > With regards to the capital asset pricing model, > relaxing assumptions about: > > A) taxes will reduce differences between the > capital market lines of different investors. CAPM is based in a no tax world so any differences wouldn’t be due to taxes in the first place. > > B) transaction costs will make investors more > likely to sell, and less likely to hold. There are no transaction costs in CAPM so introducing them would cause investors to be more likely to hold. > > C) homogeneous expectations will result in the > SML appearing more as a band instead of a line. This seems to be correct, but feels like a trap. > > D) risk free borrowing and lending rates results > in a lower intercept and steeper slope. Shouldn’t lower the intercept and without risk-free borrowing there would be no line above the efficient frontier.
C
i’d go C. on D i’d think if you relaxed assumptions about RF borrowing you’d wind up with a higher intercept, no? i could see maybe a steeper slope b/c more risk per unit of reward if you have to pay up in borrowing costs? so yeah i’d go C but talk to me on D if anyone knows what would happen to intercept and slope- i’m curious.
C. If investors have different expectations about the risk and returns of stocks they will each have a different sharpe ratio and “market” portfolio. Therefore SML becomes a band not a line. Introduction of taxes would affect high and low tax bracket investors differently hence different cmls. Not A. The current assumption is no transaction costs. Relaxing this assumption (= some transaction costs) would make investors more liklely to hold and less likely to sell. Not B. Relaxing assumptions about risk free borrowing and lending will change from a line to a curve. Not D. What’s the answer, are we all right?
on D, if you relax the assumption you would get a curve after the Market portfolio on the CML.
Yeah, it would either be kinked or just follow the positive slope of the EF.
We are all going to get it wrong.
line to a curve? hmm… this sounds vaguely familiar back from L1 PM studies… will take a look at the books to check out what the graphs look at.
Hurricane Wrote: ------------------------------------------------------- > C. > > If investors have different expectations about the > risk and returns of stocks they will each have a > different sharpe ratio and “market” portfolio. > Therefore SML becomes a band not a line. > > Introduction of taxes would affect high and low > tax bracket investors differently hence different > cmls. Not A. > > The current assumption is no transaction costs. > Relaxing this assumption (= some transaction > costs) would make investors more liklely to hold > and less likely to sell. Not B. > > Relaxing assumptions about risk free borrowing and > lending will change from a line to a curve. Not > D. > > What’s the answer, are we all right? Here comes the poster named Hurricane. The man the authorities tried to blame. For something that he never done. But one time he could have been champion of the world. C
So it is C?
so just for my learning purposes, would the intercept in D then be lower? if so why?
mwvt9 Wrote: ------------------------------------------------------- > So it is C? We all got it right! Banny, intercept would not change, there would be a kink after the market portfolio. Anything above the market portfolio on the CML is borrowing/lending so if the rates changes, your going to have a kink there.
If there were no risk free lending then there would be no CAL, CML or anything…I think. The curve about the Market portfolio that everbody is talking about is when there are restriction on the level of borrowing from at the risk free rate (so you are actually borrowing to invest more in the market portfolio). Edit: I am not sure what relaxing assumptions on risk free lending and borrowing means though. More or less or none at all…
Intercept has to be R(f) as, by definition, if something has no variance its return is a risk free rate. So (as long as there is a risk free security) you can buy it and the intercept is the risk free rate. If you reduce (increase) the risk free rate the intercept will reduce (increase). Relaxing the assumption presumably eitehr means there is no risk free security in which case the line is just the efficeint frontier; or that you can’t borrow at R(f), in this case you get a line then a curve (as deep 2002 said).
This was covered in LI, I haven’t seen in mentioned in L2, where’d you see the question Pink?
That makes sense.