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

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

Answer 1

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

Greater the Beta, greater would be the expected return on stock. Lower the Beta, lower would be the expected return on the stock.

Let Risk free return and market return be 5% and 10% respectively

At Beta = 1.5
Expected Return =	Risk free Return + (Market Return - Risk free return)* Beta
Expected Return =	5% + (10% - 5%)*1.5
Expected Return =	12.50%
At Beta= 0.5
Expected Return =	Risk free Return + (Market Return - Risk free return)* Beta
Expected Return =	5% + (10% - 5%)*0.5
Expected Return =	7.50%