Question

Assume that the UK short-term government bond yield is 2% and the FTSE All Shares Index return is 5%.

Stock	I	II	III	IV	V
Actual returns (%)	4.5	4.7	5.3	5.3	5.2
CAPM beta	0.8	0.9	1	1.1	1.2

Which of the following is true?

	A.	The actual returns of Stocks I and V are equal to their expected returns
	B.	The actual returns of Stocks III and V are equal to their expected returns
	C.	The actual returns of Stocks I and III are equal to their expected returns
	D.	The actual returns of Stocks II and IV are equal to their expected returns
	E.	None of the above

Answer 1

Expected Return of Stock 1 =Risk Free Rate +Beta*(Market Return-Risk Free Rate) =2%+0.8*(5%-2%) =4.4%
Expected Return of Stock 2 =Risk Free Rate +Beta*(Market Return-Risk Free Rate) =2%+0.9*(5%-2%) =4.7%
Expected Return of Stock 3 =Risk Free Rate +Beta*(Market Return-Risk Free Rate) =2%+1*(5%-2%) =5.0%
Expected Return of Stock 4 =Risk Free Rate +Beta*(Market Return-Risk Free Rate) =2%+1.1*(5%-2%) =5.3%
Expected Return of Stock 5 =Risk Free Rate +Beta*(Market Return-Risk Free Rate) =2%+1.2*(5%-2%) =5.6%

Option d is correct option The actual returns of Stocks II and IV are equal to their expected returns