Question: 6. Equilibrium pricing: Let the subscripts: j = 0 denote the risk-free asset, j = 1,...,n the set of available risky securities, and M

6. Equilibrium pricing: Let the subscripts: j = 0 denote the risk-free asset, j = 1,...,n the set of available risky securities, and M the market portfolio. For the questions that follow, assume that CAPM provides an accurate description of reality. a. b. C. d. State the CAPM equation. (1) Use the CAPM equation to show that the following condition is true s; SM for any j. What is the significance of this condition when interpreted in the context of the capital market line? (5) Assume that B = 0.8, M = 0.1 and r = 0.05. Using the CAPM, determine the expected return from holding one unit of asset j for one period. (2) Given your answer to c.), what could you conclude (from the perspective of the security market line) if a market survey indicated that the forecasted one- period return on asset j was 8 percent? Describe and motivate the rational trading response that is consistent with your conclusion. (4)

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