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Answer: Investors have the same expectations regarding the expected returns and the variance of returns of all assets.
D is correct. CAPM assumes investors have identical expectations with respect to expected returns, the variance of returns, and the correlation matrix representing the correlation structure between all pairs of stocks. The other choices are not assumptions of the CAPM. A is incorrect because CAPM assumes no transaction costs, taxes, or other frictions. B is incorrect as CAPM assumes any individual investor's allocation decision cannot change the market prices. C is incorrect for the same reason as A, CAPM assumes no transaction costs, taxes, or other frictions.
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In recommending that a retirement fund modify its investment distribution strategy in accordance with the Capital Asset Pricing Model (CAPM), a risk expert aims to better align the fund's strategies with CAPM principles. To support this recommendation, the expert compiles a list of the foundational assumptions underlying the CAPM. Which of the following options correctly identifies a fundamental assumption of the Capital Asset Pricing Model?
A
There are transaction costs associated with buying and selling assets.
B
An individual investor can affect the price of a stock by buying or selling that stock.
C
Investors make their investment decisions by taking into account their personal income taxes.
D
Investors have the same expectations regarding the expected returns and the variance of returns of all assets.