State whether the following is inconsistent with an efficient capital market, the CAPM, or both:
Security with only diversifiable risk has an expected return that exceeds the riskfree rate of return
Answer:
This statement is inconsistent with both.
Explanation:
The statement made in the question is inconsistent with both the Capital Asset Pricing Model (CAPM) and an efficient capital market because both models state that the cost of capital depends only on systematic risk or non-diversifiable risk. Thus the statement contradicts the models of the CAPM and Efficient Capital Market.
