Question

Consider the following two scenarios for the economy and the returns in each scenario for the...

Consider the following two scenarios for the economy and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.

Rate of Return (%) Scenario

Scenario

Bust: Market -6 / Aggressive Stock A -12 / Defensive Stock D -4

Boom: Market 15 / Aggressive Stock A 36 / Defensive Stock D 10

a) Find the beta of each stock. In what way is stock D defensive?

b) If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock.

c) If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks?

d) Which stock seems to be a better buy on the basis of your answers to (a) through (c)?

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Answer #1

Stock D is defensive as Beta is lower.

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