3. Stock A\'s beta is 1.5 and Stock B\'s beta is 0.5. Which of the following sta

Question

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

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

EXPLAIN ANSWER AND SHOW WORK

Explanation / Answer

Assuming the CAPM is correct,the following statements must be true-

c.When held in isolation, Stock A has more risk than Stock B.This is because the beta of stock A is higher than that of stock B.

e.In equilibrium, the expected return on Stock A will be greater than that on B.This is because an investor would always expect a higher return for taking higher risks.

The following statements must not be true because -

a.Stock A would not be a more desirable addition to a portfolio then Stock B.This is because it is possible that stock B has equal return as compared to stock A.

b.Since the beta of stock A is greater than beta of stock B an investor will expect a higher return for taking higher risks.

d.Stock B would not be a more desirable addition to a portfolio than A because an investor who would like to take a risk would prefer stock A over stock B

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