Question

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.

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.