In asset pricing models, which of the following is true?

In asset pricing models, which of the following is true?

• A. The CAPM reflects a linear risk-return relationship.
• B. The APT indicates that risk-return relationships are linear.
• C. The APT relies solely on market return and stock volatility.
• D. The CAPM only considers the market return.

Answer: (A)

The Capital Asset Pricing Model (CAPM) indeed reflects a linear risk-return relationship, which is one of its foundational principles. The CAPM posits that the expected return on an asset is proportional to its systematic risk, as measured by beta. This means that as the level of risk associated with an asset increases, the expected return on that asset also increases in a linear fashion. This correlation is graphically represented by the Security Market Line (SML), demonstrating that there is a direct and predictable relationship between risk and return in efficient markets. The other options presented do not accurately represent the characteristics of the asset pricing models discussed. For instance, while the Arbitrage Pricing Theory (APT) involves multiple factors and can also imply relationships between risk and return, it is not necessarily confined to a linear model, as it allows for a more complex array of influences. Thus, the assertion that the APT solely reflects linear risk-return relationships is misleading. Additionally, the APT operates under different assumptions compared to CAPM, including that it does not rely solely on market return and stock volatility, but can incorporate a variety of economic factors affecting asset returns. As for the CAPM, it indeed takes market return into account through the risk-free rate and the expected market

The Capital Asset Pricing Model (CAPM) indeed reflects a linear risk-return relationship, which is one of its foundational principles. The CAPM posits that the expected return on an asset is proportional to its systematic risk, as measured by beta. This means that as the level of risk associated with an asset increases, the expected return on that asset also increases in a linear fashion. This correlation is graphically represented by the Security Market Line (SML), demonstrating that there is a direct and predictable relationship between risk and return in efficient markets.

The other options presented do not accurately represent the characteristics of the asset pricing models discussed. For instance, while the Arbitrage Pricing Theory (APT) involves multiple factors and can also imply relationships between risk and return, it is not necessarily confined to a linear model, as it allows for a more complex array of influences. Thus, the assertion that the APT solely reflects linear risk-return relationships is misleading.

Additionally, the APT operates under different assumptions compared to CAPM, including that it does not rely solely on market return and stock volatility, but can incorporate a variety of economic factors affecting asset returns. As for the CAPM, it indeed takes market return into account through the risk-free rate and the expected market