CAPM and Applying CAPM

Capital Asset Pricing Model (CAPM) a. What is two-fund portfolio separation and why is it important? b. Show graphically (in return-standard deviation space) how 2-fund separation works in the context of the CAPM. C. Explain and show how risk averse investors are better off with capital markets. d. What are some of the assumptions that need to hold in order for the CAPM to be applied and why are they important? e. Suppose a stock has a covariance with the market of 0.3 and the market has a variance of 0.2. What is the stock's beta? Is the stock more or less risky than the market? Applying the CAPM a. Show graphically (in return-standard deviation space) how some investors may be borrowers, while others may be lenders in the capital markets under CAPM. b. Show how the existence of differences between the borrowing and lending rates may affect both borrowers and lenders. Assume that the borrowing rate is higher than the lending rate. c. Show and explain how the securities market line (SML) plots the relationship between risk and return. d. Explain how a security may be "undervalued" or "overvalued" based on the SML c. What are some of the criticisms often cited when implementing the CAPM? Do you think the CAPM should be used by practitioners when assessing an assets risk/return? Why