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THE ECONOMICS OF FINANCIAL MARKETS
R. E. BAILEY
Exercises for Chapter 6
The capital asset pricing model
1. The following information is provided for a stock market:
μ
j
β
j
Asset 1
6.6%
0.4
Asset 2
9.8%
1.2
Asset 3
12.2%
1.8
Notation:
μ
j
=
expected rate of return on asset
j
;
β
j
=
betacoefﬁcient for asset
j
,
j
= 1
,
2
,
3
.
(a) In the context of the Capital Asset Pricing Model (CAPM), deﬁne the ‘betacoefﬁcient’,
β
j
, corresponding to asset
j
. Discuss how assets’ betacoefﬁcients should be interpreted
and explain how their values can be obtained in practice.
(b) Assuming that a riskfree asset is available, explain and interpret the Security Market
Line (SML) in the context of the CAPM. Construct the SML from the given information
and interpret the values of its coefﬁcients.
(c) Now suppose a riskfree asset is
not
available, although the other assumptions of the
CAPM remain valid. How should the SML be constructed and interpreted in this case?
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 Spring '11
 CRABBE

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