An underlying assumption to the CAPM model is that an individual can choose an investment combining the return on the risk-free asset with the market rate of return, and this will provide superior returns to the efficient frontier at all points except M, where they are equal.

Question

Quizplus · Accepted Answer

This is a correct statement about the CAPM model. The efficient frontier represents the set of portfolios with the highest expected return for a given level of risk. According to the CAPM, all investors should hold a combination of the risk-free asset and the market portfolio that lies on the capital market line (CML), which is a straight line that connects the risk-free rate to the market portfolio. This optimized portfolio provides the highest expected return for any given level of risk and is located at the point of tangency between the CML and the efficient frontier, which is point M. At any other point on the efficient frontier, the optimal portfolio will contain some combination of the risk-free asset and the market portfolio.

An Underlying Assumption to the CAPM Model Is That an Individual