The answer to the question is highlighted in red. Explanations are highlighted in green.
a. When the investment is held in isolation—that is, the investor holds a single-asset portfolio.
b. When the investment is held in a well-diversified portfolio.
c. When the total risk associated with the investment is comprised of firm-specific risk only.
d. When the total
risk associated with the investment is comprised of market risk only.
e. Investors
should always expect to be paid for the total risk associated with an
investment.
According to the CAPM, investors should be paid only for
the relevant risk associated with an investment—that is, its market risk— that
cannot be diversified away. Total risk = Firm-specific risk + Market risk. As a
result, according to the CAPM, total risk will be rewarded only when Total risk
= Market risk—that is, firm-specific risk equals zero. Does such an investment
exist? A mutual fund that invests in a
broad base of stocks and bonds is close to such a situation.