Unit study guide · NISM Series XXI-B
Introduction to Capital Market Theory
6 questions in this unit
What this unit covers
- Which risk measures appear on the capital market line and security market line, respectively?
- The risk-free rate is 5%, expected market return 11%, and beta 1.5. What return does the capital asset pricing model require?
- A portfolio places 60% in an asset with beta 1.3 and 40% in one with beta 0.8. What is portfolio beta?
- A security’s forecast return is 13%, but its beta implies a 10% required return. Where does the forecast plot relative to the security market line?
- A two-factor model has a 4% baseline, factor premiums of 5% and 2%, and corresponding loadings 1.2 and 0.5. What return is implied?
- An investor borrows 20% of own capital at 5% and invests 120% in the market, expecting 10% return and 15% volatility. What results?
Key ideas
From the practice bank · 1
Which risk measures appear on the capital market line and security market line, respectively?
The capital market line uses standard deviation, while the security market line uses beta. The first concerns efficient portfolios and the second relates expected return to systematic risk. Remember: The two lines use different risk axes and have different applications.
Hint Distinguish total portfolio volatility from sensitivity to the market. Common mistake: Using beta and total volatility interchangeably.
XXI-B-095From the practice bank · 2
The risk-free rate is 5%, expected market return 11%, and beta 1.5. What return does the capital asset pricing model require?
The capital asset pricing model requires 14.00% because beta scales the market risk premium. Market premium = 11% − 5% = 6%. Required return = 5% + 1.5 × 6% = 14%. Remember: CAPM applies beta to the market risk premium, not the entire market return.
Hint Apply beta to the return above the risk-free baseline. Common mistake: Forgetting to subtract and then add back the risk-free component.
XXI-B-096From the practice bank · 3
A portfolio places 60% in an asset with beta 1.3 and 40% in one with beta 0.8. What is portfolio beta?
Portfolio beta is 1.10 because beta combines linearly with the investment weights. Working: 0.60 × 1.3 + 0.40 × 0.8 = 0.78 + 0.32 = 1.10. Remember: Portfolio beta is the weighted average of constituent betas.
Hint Aggregate market sensitivity according to the portfolio weights. Common mistake: Using the unweighted average when the allocations differ.
XXI-B-097From the practice bank · 4
A security’s forecast return is 13%, but its beta implies a 10% required return. Where does the forecast plot relative to the security market line?
The forecast plots above the line because 13% exceeds the 10% model-required return. This is positive forecast alpha, not a guarantee that the excess return will occur. Remember: A forecast above the security market line implies positive model-relative expected alpha.
Hint Compare the forecast with the model-required return at the same beta. Common mistake: Treating a forecast opportunity as certain realised outperformance.
XXI-B-098From the practice bank · 5
A two-factor model has a 4% baseline, factor premiums of 5% and 2%, and corresponding loadings 1.2 and 0.5. What return is implied?
The model implies 11.00% because the two factor contributions add to the baseline. First contribution = 1.2 × 5% = 6%. Second contribution = 0.5 × 2% = 1%. Total = 4% + 6% + 1% = 11%. Remember: A multifactor model adds distinct exposure-weighted factor premiums.
Hint Match each exposure to its own factor premium, then include the baseline. Common mistake: Applying one factor loading to every premium or omitting the baseline.
XXI-B-099From the practice bank · 6
An investor borrows 20% of own capital at 5% and invests 120% in the market, expecting 10% return and 15% volatility. What results?
Expected return is 11% and volatility is 18% under the stated frictionless model. Return on own capital = 1.20 × 10% − 0.20 × 5% = 11%. The borrowing rate is fixed, so volatility = 1.20 × 15% = 18%. Leverage can also magnify realised losses. Remember: Leveraging a market portfolio changes both expected return and total volatility.
Hint Borrowing adds market exposure but also creates an interest obligation. Common mistake: Adding investment exposure without deducting borrowing cost or increasing risk.
XXI-B-100