Question

The shares of Lambunu Ltd have a negative return correlation with the market portfolio. According to the CAPM, which of the following statement(s) regarding the expected return on the shares is (are) most likely to be true?

1. The expected return will be less than the expected return on the market portfolio.
2. The expected return will be less than the riskfree rate of return.

Answer 1

Given that the shares of Lambunu Ltd have a negative return correlation with the market portfolio, which means that the beta of lambunu is negative.

So Using CAPM, Expected return on stock = Risk free rate + beta * Market risk premium

Expected return in stock = Risk free rate - Beta* Market risk premium

This means, Expected return on stock < Risk free rate (if Beta < = -1) and Expected return> Risk free rate (if Beta>-1).

Answer is The expected return will be less than the expected return on the market portfolio.