- CFA Exams
- CFA Level I Exam
- Study Session 18. Portfolio Management (1)
- Reading 53. Portfolio Risk and Return: Part II
- Subject 3. The Capital Asset Pricing Model

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**CFA Practice Question**

The capital asset pricing model (CAPM) states that the expected ______

A. risk premium on an investment is proportional to its beta.

B. rate of return on an investment is proportional to its beta.

C. rate of return on an investment depends on the risk-free rate and the market rate of return.

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**User Contributed Comments**
13

User |
Comment |
---|---|

murli |
C. missing the beta part of the SML equation. |

murli |
So it is wrong, correct answer is A. |

Iceblue |
but A is also not correct since there is another alpha term, it is not mathematically proportional,right? |

muloma |
CAPM uses the SML which is plot of the return on the market against the systematic risk (beta) and the straight line graph shows proportionality between MRP and beta. A is correct. |

Sidd2000 |
expected return also depends on risk free rate, so that's why expected risk premium is more correct |

cFa106 |
Risk premium on an investment=beta x (...), while expected return= RFR+beta x (...). the question is all about the formal equation |

lagoste |
I thought about risk premium being only: (RM - RFR), therefore it does not involve beta. however, if you think about the equation, A is correct. |

brandsat |
C is correct, it does not say "proportional", only "depends" However A is more correct and related to the CAPM. |

jinquanli |
the required rate of return depends on the risk free rate and beta, the expected rate of return depends on the future price and dividend returns. |

dblueroom |
I thought it was B. because expected risk premium is fixed, while beta affects expected return on an investment. |

Profache |
C is wrong. It is also dependent on the beta of the stock |

bodduna |
Well. Risk Premium = Beta*ERP. I just overlooked. I mistook "expected" for "equity" |

cmacewen |
The CAPM definition is that it precisely determines the expected return from an assets beta. The expected risk premium is the difference between the expected market risk and the risk free rate. |