Investments, tenth edition

  SOLUTIONS TO CONCEPT CHECKS 

    1.  The SCL is estimated for each stock; hence we need to estimate 100 equations. Our sample 

consists of 60 monthly rates of return for each of the 100 stocks and for the market index. Thus 

each regression is estimated with 60 observations. Equation 13.1 in the text shows that when 

stated in excess return form, the SCL should pass through the origin, that is, have a zero intercept.  

   2.  When the SML has a positive intercept and its slope is less than the mean excess return on the market 

portfolio, it is flatter than predicted by the CAPM. Low-beta stocks therefore have yielded returns 

that, on average, were higher than they should have been on the basis of their beta. Conversely, high-

beta stocks were found to have yielded, on average, lower returns than they should have on the basis 

of their betas. The positive coefficient on  g  

2

  implies that stocks with higher values of firm-specific 

risk had on average higher returns. This pattern, of course, violates the predictions of the CAPM.  

   3.     a.    According to Equation 13.5,  g  

0

  is the average return earned on a stock with zero beta and zero 

firm-specific risk. According to the CAPM, this should be the risk-free rate, which for the 

1946–1955 period was 9 basis points, or .09% per month (see  Table 13.1 ). According to the 

CAPM,  g  

1

  should equal the average market risk premium, which for the 1946–1955 period 

was 103 basis points, or 1.03% per month. Finally, the CAPM predicts that  g  

3

 , the coefficient 

on firm-specific risk, should be zero.  

  b.  A positive coefficient on beta-squared would indicate that the relationship between risk and 

return is nonlinear. High-beta securities would provide expected returns more than proportional 

to risk. A positive coefficient on  s ( e ) would indicate that firm-specific risk affects expected 

return, a direct contradiction of the CAPM and APT.        

bod61671_ch13_414-444.indd   444

bod61671_ch13_414-444.indd   444

7/17/13   3:47 PM

7/17/13   3:47 PM

Final PDF to printer

---