Question

1. The market rate of return is 10.5% and the risk-free rate is 1.1%. What will be the change in a stock's expected rate of return if its beta increases from 0.8 to 1.0?

18.80%

1.88%

1.62%

16.20%

2. "If the market portfolio is expected to return 13%, then a portfolio that is expected to return 10%: "

		plots above the security market line
		plots to the right of the market on an SML graph.
		is diversified.
		has a beta that is less than 1.0.

Answer 1

Question 1:

When Beta = 0.8

Expected return on stock = 1.1% + 0.8 * (10.5% - 1.1%)

Expected return on stock = 1.1% + 7.52% = 8.62%

When Beta = 1.0

Expected return on stock = 1.1% + 1.0 * (10.5% - 1.1%)

Expected return on stock = 1.1% + 9.40% = 10.5%

Change = 10.5% - 8.62% = 1.88%

Question 2:

Expected return on market portfolio > expected return on the given portfolio. This would imply its beta is less than the beta of market portfolio which is 1.0.

Hence, the correct statement is: has a beta that is less than 1.0.