Question

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements...

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

a.

Stock A would be a more desirable addition to a portfolio then Stock B.

b.

In equilibrium, the expected return on Stock B will be greater than that on Stock A.

c.

When held in isolation, Stock A has more risk than Stock B.

d.

Stock B would be a more desirable addition to a portfolio than A.

e.

In equilibrium, the expected return on Stock A will be greater than that on B.

Homework Answers

Answer #1

Answer - Option e

Based on CAPM, expected return on a stock is directly proportional to beta on that stock. So, with higher beta on Stock A, expected return on stock A would be higher. Hence, option e is correct. (This also makes option b incorrect.)

Option a, d is incorrect. This cannot be ascertained unless knowing the portfolio or expected risk profile of portfolio.

Option c is incorrect. In isolation, the risk of stock is assessed by standard deviation of stock and not by beta.

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