If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected excess return must be
A) inversely proportional to the risk-free rate.
B) inversely proportional to its standard deviation.
C) proportional to its weight in the market portfolio.
D) proportional to its standard deviation.
E) proportional to its beta coefficient.

Question

Quizplus · Accepted Answer

In the context of the Capital Asset Pricing Model (CAPM), the expected excess return on a well-diversified portfolio is proportional to its beta coefficient. The beta measures the portfolio's sensitivity to market movements, and according to CAPM, this is the only risk that should affect the expected return of a well-diversified portfolio, as idiosyncratic risks are diversified away.

If Arbitrage Opportunities Are to Be Ruled Out, Each Well-Diversified