Question 1: The Capital Asset Pricing Model (CAPM) is a widely used concept in finance. The Model is expressed graphically by the Security Market Line (SML). Within the context of investment, explain how CAPM can be useful to investors.
Question 2: Explain Efficient Market Hypothesis (EMH) and the different types of market efficiency. Do stock market anomalies contradict the concept of market efficiency? Explain.
Question 3: The distributions of rates of return for Security AA and Security BB are given below:
State of Probability of Security
Economy State Occurring AA BB
Boom 0.2 30% -10%
Normal 0.6 10 5
Recession 0.2 -5 50
Based on the above information can we conclude that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB. Why? Or why not?