CAPM assumptions

First Unrestricted borrowing or lending at the risk-free rate of interest refers to the assumption in portfolio theory and the Capital Asset Pricing Model (CAPM) that investors can borrow or lend money at a risk-free rate. This assumption is made to provide a minimum level of return required by investors. However, in reality, it is not possible for individual investors to borrow at the risk-free rate because the risk associated with individual investors is much higher than that associated with the government. This inability to borrow at the risk-free rate results in the slope of the Security Market Line (SML) being shallower in practice than in theory. Second The single-period transaction horizon assumption in finance refers to the assumption that a holding period of one year is used to compare the returns on different securities. This assumption is made because returns on securities are usually quoted on an annual basis, and it allows for comparability between different securities. For example, a return over six months cannot be directly compared to a return over 12 months. While many investors hold securities for longer than one year, using a standardised one-year holding period simplifies the analysis and facilitates comparisons.