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 than Stock B.
B) In equilibrium, the expected return on Stock B will be greater than that on Stock A.
C) Stock B would be a more desirable addition to a portfolio than Stock A.
D) In equilibrium, the expected return on Stock A will be greater than that on Stock B.

Question

Quizplus · Accepted Answer

According to the CAPM, the expected return on a stock is equal to the risk-free rate plus the stock's beta multiplied by the market risk premium. Since Stock A has a higher beta than Stock B, it is expected to have a higher return than Stock B to compensate investors for the higher level of risk. Therefore, in equilibrium, the expected return on Stock A will be greater than that on Stock B. Choice A and C cannot be determined solely based on the beta values of the stocks.

Stock A's Beta Is 1