Given are the following two stocks A and B: $$\begin{array} { c c c }
&{ \text { Expected } } \
\text { Security } & \text { Rate of return } & \text { Beta } \
\text { A } & 0.12 & 1.2 \
\text { B } & 0.14 & 1.8 \
\hline
\end{array}$$ If the expected market rate of return is 0.09, and the risk-free rate is 0.05, which security would be considered the better buy, and why?
A) A because it offers an expected excess return of 1.2%.
B) B because it offers an expected excess return of 1.8%.
C) A because it offers an expected excess return of 2.2%.
D) B because it offers an expected return of 14%.
E) B because it has a higher beta.

Question

Given are the following two stocks A and B: $$\begin{array} { c c c } 
&{ \text { Expected } } \
\text { Security } & \text { Rate of return } & \text { Beta } \
\text { A } & 0.12 & 1.2 \
\text { B } & 0.14 & 1.8 \
\hline
\end{array}$$ If the expected market rate of return is 0.09, and the risk-free rate is 0.05, which security would be considered the better buy, and why?
A) A because it offers an expected excess return of 1.2%.
B) B because it offers an expected excess return of 1.8%.
C) A because it offers an expected excess return of 2.2%.
D) B because it offers an expected return of 14%.
E) B because it has a higher beta.

Quizplus · Accepted Answer

The expected excess return for a stock is calculated using the Capital Asset Pricing Model (CAPM): Expected return = Risk-free rate + Beta * (Market return - Risk-free rate). For stock A, the expected return is 0.05 + 1.2 * (0.09 - 0.05) = 0.098. The actual expected return is 0.12, so the excess return is 0.12 - 0.098 = 0.022 or 2.2%. For stock B, the expected return is 0.05 + 1.8 * (0.09 - 0.05) = 0.122, and the actual expected return is 0.14, so the excess return is 0.14 - 0.122 = 0.018 or 1.8%. Therefore, stock A offers a higher excess return.

Given Are the Following Two Stocks a and B If the Expected Market Rate of Return Is 0