Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%.Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%.Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B.The correlation between the two stocks' returns is zero Which of the following statements is CORRECT?
A)Portfolio AB's standard deviation is 17.5%.
B)The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
C)The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.
D)Portfolio AB's expected return is 11.0%.
E)Portfolio AB's beta is less than 1.2.

Question

Quizplus · Accepted Answer

The CAPM suggests that stocks with the same beta should have the same expected return. Since both stocks have a beta of 1.2, they should have the same expected return if they are in equilibrium. Stock A has a higher expected return than Stock B, indicating that Stock B is overvalued if Stock A is correctly valued.

Stock a Has an Expected Return of 12%, a Beta