Question

Select the best answer. Stock C has a required rate of return (r_s) of 14%, an expected return (^r ) of 15% and a beta of 1.5. Stock D has a required rate of return (r_s) of 12%, an expected return (^r ) of 11%.and a beta of .95 You plan to add either Stock C or Stock D to an existing portfolio.

Group of answer choices

a. You would select Stock C because it has the highest expected return (^r ), therefore the highest potential reward.

b. You select Stock C because its expected return (^r ) is higher than its required return (rs), therefore has the most attractive risk/reward profile.

c. You would select Stock D because it has the lowest expected return (^r ), therefore has the least potential loss.

d. You would select Stock D because its expected return (^r ) is lower than its required return (rs), therefore has the most attractive risk/reward ratio.

e. You would select neither stock because each has a beta that is equal or less than its expected return (^r ).

Answer 1

Ans:- Required rate of return is the minimum rate of return that an investor will accept the risk of buying or owning any stock whereas the Expected rate of return is the return which investors anticipate or expect to get.

So a rational investor would buy a stock if the required rate of return < expected rate of return.

In this case, stock C has required return (14%) < expected return (15%), therefore investor should invest in stock C.

Option (b) is the right answer i.e  You select Stock C because its expected return is higher than its required return (rs), therefore has the most attractive risk/reward profile.

Note:- If this answer helps you pls give thumbs up.