"Portfolio Management":Portfolio Risk and Return: Part II

C is correct. Because Stock X has a higher systematic risk level compared with Stock Y, its expected return will be higher than that of Stock Y.

A is incorrect because Stock X has a higher systematic risk level compared to Stock Y, implying a higher (not the same) expected return compared to Stock Y.

B is incorrect because Stock X has a higher systematic risk level compared to Stock Y, implying a higher (not lower) expected return compared to Stock Y.

A is correct. The CAPM requires that there are no restrictions on short selling (which is an assumption underlying frictionless markets) and that the amount invested in an asset can be as much or as little as the investor wants (that is, investments are infinitely divisible). The CAPM also assumes that all investors analyze securities in the same way using the same inputs for future cash flows and the same probability distributions; that is, it assumes that investors have homogenous expectations.

B is incorrect because no restrictions on short selling assets (which is an assumption underlying frictionless markets) is an assumption of the CAPM.

C is incorrect because an investor being able to invest as much or as little in an asset (that is, investments are infinitely divisible) is an assumption of the CAPM.