Consider the following information for three stocks: Stock X, Stock Y, and Stock

Question

Consider the following information for three stocks: Stock X, Stock Y, and Stock Z. The returns on each of the three stocks are positively correlated, but they are not perfectly correlated. (That is, all of the correlation coefficients are between 0 and 1, or 0 < ? < 1). Expected Standard Stock Return Deviation Beta Stock X 10% 20% 1.0 Stock Y 10 20 1.0 Stock Z 12 20 1.4 Portfolio A has half of its funds invested in Stock X and half invested in Stock Y. Portfolio B has one third of its funds invested in each of the three stocks. The risk-free rate (rrf) is 5 percent, and the market is in equilibrium. (That is, the required return equals the expected return on all assets.) What is the expected return on the market, rMKT?

Explanation / Answer

Using StockA (or any stock),

10% =kRF + (kM

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