Question

Suppose that the CAPM is the correct model of expected returns. Which of the following stocks will have the highest expected return?

Group of answer choices

A stock with beta of 0.8 and a standard deviation of returns equal to 20%

A stock with beta of 0.65 and a standard deviation of returns equal to 27.5%

A stock with beta of 0.5 and a standard deviation of returns equal to 35%

A stock with beta of 0.6 and a standard deviation of returns equal to 30%

A stock with beta of 0.7 and a standard deviation of returns equal to 25%

Answer 1

CAPM equation is as follows:

Expected return, risk free return, market return

Now as the risk free return and the market return will remain constant, the stock with the highest beta will have the higher expected return

Standard deviation is not to be considered

So the highest expected return will be of the stock with the beta of 0.8