Capital Asset Pricing Model (CAPM) MCQs

By: Prof. Dr. Fazal Rehman Shamil | Last updated: July 12, 2024

What does the Capital Asset Pricing Model (CAPM) primarily assess?
A) The risk of a portfolio
B) The expected return of an asset based on its risk
C) The total value of an investment
D) The liquidity of an investment
Answer: B) The expected return of an asset based on its risk

Which formula represents the CAPM equation?
A) 𝐸(𝑅𝑖) = 𝑅𝑓 + 𝛽𝑖(𝑅𝑚 − 𝑅𝑓)
B) 𝐸(𝑅𝑖) = 𝑅𝑓 + 𝛽𝑖(𝑅𝑖 − 𝑅𝑓)
C) 𝐸(𝑅𝑖) = 𝑅𝑓 + 𝛼𝑖(𝑅𝑚 − 𝑅𝑓)
D) 𝐸(𝑅𝑖) = 𝑅𝑓 + 𝛽𝑖(𝑅𝑓 − 𝑅𝑚)
Answer: A) 𝐸(𝑅𝑖) = 𝑅𝑓 + 𝛽𝑖(𝑅𝑚 − 𝑅𝑓)

In the CAPM formula, what does 𝑅𝑓 represent?
A) The expected return of the market
B) The risk-free rate of return
C) The return on a risky asset
D) The market return minus the risk-free rate
Answer: B) The risk-free rate of return

What does 𝛽𝑖 measure in the CAPM equation?
A) The total risk of an asset
B) The systematic risk of an asset relative to the market
C) The risk-free rate
D) The market return
Answer: B) The systematic risk of an asset relative to the market

What is the “market risk premium” in the CAPM formula?
A) The difference between the risk-free rate and the market return
B) The difference between the market return and the risk-free rate
C) The total return of the market
D) The return on a risk-free asset
Answer: B) The difference between the market return and the risk-free rate

How is 𝛽𝑖 typically interpreted?
A) A 𝛽𝑖 greater than 1 indicates higher risk and higher return compared to the market
B) A 𝛽𝑖 less than 1 indicates higher risk and lower return compared to the market
C) A 𝛽𝑖 of 0 indicates that the asset is risk-free
D) A 𝛽𝑖 of 1 indicates that the asset has no systematic risk
Answer: A) A 𝛽𝑖 greater than 1 indicates higher risk and higher return compared to the market

If the market return is 12%, the risk-free rate is 3%, and the beta of an asset is 1.2, what is the expected return of the asset according to CAPM?
A) 10.8%
B) 13.8%
C) 14.4%
D) 15.6%
Answer: C) 14.4%

Which of the following is an assumption of the CAPM?
A) Investors have different risk preferences
B) Markets are not efficient
C) There are no transaction costs or taxes
D) All investors have access to insider information
Answer: C) There are no transaction costs or taxes

What does the “security market line” (SML) represent?
A) The relationship between total risk and return of an investment
B) The relationship between the expected return and systematic risk of a security
C) The historical performance of the market
D) The risk-free rate of return
Answer: B) The relationship between the expected return and systematic risk of a security

If an asset’s beta is less than 1, what does this indicate?
A) The asset is more volatile than the market
B) The asset is less volatile than the market
C) The asset has no risk
D) The asset provides a lower return than the market
Answer: B) The asset is less volatile than the market

What is the primary use of the CAPM?
A) To calculate the intrinsic value of an asset
B) To determine the cost of equity capital
C) To predict the future price of an asset
D) To measure a company’s operational efficiency
Answer: B) To determine the cost of equity capital

What does a beta of 0 imply about an asset?
A) The asset is perfectly correlated with the market
B) The asset is highly volatile compared to the market
C) The asset is uncorrelated with the market
D) The asset has higher risk than the market
Answer: C) The asset is uncorrelated with the market

Which of the following is NOT a limitation of CAPM?
A) Assumes that all investors have the same expectations
B) Assumes markets are perfectly competitive
C) Assumes that all investors have access to the same information
D) Accounts for all types of risks including unsystematic risk
Answer: D) Accounts for all types of risks including unsystematic risk

In CAPM, what does the slope of the Security Market Line (SML) represent?
A) The risk-free rate
B) The total risk premium
C) The market risk premium
D) The standard deviation of market returns
Answer: C) The market risk premium

How does CAPM view diversifiable risk?
A) As the primary source of risk for investors
B) As irrelevant because it can be eliminated through diversification
C) As a key determinant of expected returns
D) As equivalent to systematic risk
Answer: B) As irrelevant because it can be eliminated through diversification

What is “alpha” in the context of CAPM?
A) The measure of an investment’s risk
B) The return earned by an investment in excess of the return predicted by CAPM
C) The difference between the risk-free rate and the market return
D) The systematic risk of a portfolio
Answer: B) The return earned by an investment in excess of the return predicted by CAPM

Which of the following statements is true about CAPM?
A) It considers only total risk in its calculations
B) It assumes all investors can borrow and lend at the risk-free rate
C) It does not account for the systematic risk of assets
D) It uses historical returns to predict future returns
Answer: B) It assumes all investors can borrow and lend at the risk-free rate

What is the main criticism of the CAPM model?
A) It requires the use of historical data for predictions
B) It assumes that investors can diversify all types of risk
C) It assumes markets are not efficient
D) It does not consider liquidity risk
Answer: D) It does not consider liquidity risk

Which of the following best describes the “risk-free rate”?
A) The rate of return on a high-risk investment
B) The return on an investment with no risk of financial loss
C) The average return of the stock market
D) The return on a diversified portfolio
Answer: B) The return on an investment with no risk of financial loss

If the risk-free rate increases while the market risk premium remains unchanged, how does this affect the CAPM expected return?
A) The expected return decreases
B) The expected return increases
C) The expected return remains unchanged
D) The effect on the expected return cannot be determined
Answer: B) The expected return increases

Which of the following is a key component of the CAPM equation?
A) Total risk of the investment
B) Systematic risk premium
C) Standard deviation of the investment
D) Past performance of the investment
Answer: B) Systematic risk premium

How does a higher beta affect the expected return according to CAPM?
A) It decreases the expected return
B) It increases the expected return
C) It has no effect on the expected return
D) It makes the expected return more volatile
Answer: B) It increases the expected return

What is the “market portfolio” in CAPM?
A) A portfolio consisting of all available assets weighted by their market values
B) A portfolio of government securities
C) A portfolio consisting of only high-risk assets
D) A portfolio of fixed-income securities
Answer: A) A portfolio consisting of all available assets weighted by their market values

What does a CAPM beta value of 1.5 imply?
A) The asset is less volatile than the market
B) The asset is more volatile than the market
C) The asset’s returns are uncorrelated with the market
D) The asset provides a guaranteed return of 1.5%
Answer: B) The asset is more volatile than the market

Which factor is NOT considered in the CAPM model?
A) Market risk premium
B) Risk-free rate
C) Company-specific risk
D) Systematic risk
Answer: C) Company-specific risk

What is the main assumption regarding investor behavior in CAPM?
A) All investors have different expectations about future returns
B) All investors have the same expectations about future returns
C) Investors prefer higher risk investments
D) Investors do not diversify their portfolios
Answer: B) All investors have the same expectations about future returns

Which of the following is NOT an assumption of the CAPM model?
A) Investors can only invest in risky assets
B) There is a risk-free rate available
C) Investors have a one-period investment horizon
D) All investors have access to the same information
Answer: A) Investors can only invest in risky assets

In CAPM, if an asset has a beta of 0.8, how does its risk compare to the market?
A) The asset has higher risk than the market
B) The asset has lower risk than the market
C) The asset has the same risk as the market
D) The risk of the asset cannot be determined
Answer: B) The asset has lower risk than the market

What effect does an increase in the market return have on the CAPM expected return of an asset?
A) It decreases the expected return
B) It increases the expected return
C) It has no effect on the expected return
D) It makes the expected return more volatile
Answer: B) It increases the expected return

How is CAPM used in the calculation of a company’s cost of equity?
A) By determining the risk-free rate and adding a risk premium
B) By estimating future cash flows and discounting them to present value
C) By calculating the historical average return of the company
D) By analyzing the company’s dividend yield
Answer: A) By determining the risk-free rate and adding a risk premium

What does the “market portfolio” include according to CAPM?
A) Only equities
B) Only fixed-income securities
C) All available assets in the market
D) Only real estate investments
Answer: C) All available assets in the market

What is “systematic risk” also known as in CAPM?
A) Diversifiable risk
B) Unsystematic risk
C) Market risk
D) Specific risk
Answer: C) Market risk

In CAPM, what does an asset’s alpha indicate?
A) The asset’s sensitivity to market movements
B) The asset’s risk relative to the market
C) The asset’s excess return relative to its expected return
D) The risk-free rate of return
Answer: C) The asset’s excess return relative to its expected return

If an asset has a negative alpha, what does it suggest about the asset’s performance?
A) The asset is outperforming the market
B) The asset is underperforming relative to its CAPM-predicted return
C) The asset has a higher risk than the market
D) The asset has no systematic risk
Answer: B) The asset is underperforming relative to its CAPM-predicted return

What is the primary purpose of using CAPM in finance?
A) To evaluate the historical performance of an asset
B) To estimate the expected return on an asset given its risk
C) To determine the fair value of a company’s stock
D) To measure the market’s overall risk
Answer: B) To estimate the expected return on an asset given its risk