Question

If the simple CAPM is valid, is the situation shown below possible? Beta Portfolio Risk-free Market Expected Return 6% 18% 14% 1.2 Possible Not possible

Answer 1

This situation is not possible.

The CAPM expected return can be calculated as ,

Re = Rf + beta (Rm - Rf)

Where Rf is the risk free rate

and Rm is the return on the market.

So, the higher the beta, the higher will be the expected return. As the beta of the market is lower than the stock A, the expected return of market should be lower.In this question it is indicating the contrary so this situation is not possible.

So, the correct option is option 2.