Stock A is a risky asset that has a beta of 1.4 and an expected return of 13.2%. Stock B is also a risky asset and has a beta of 1.25. The risk-free rate is 5.5%. Assuming both stocks are correctly priced, what is the expected return on Stock B?
A)11.90%
B)12.11%
C)12.29%
D)12.38%
E)12.46%

Question

Quizplus · Accepted Answer

The expected return on a stock can be calculated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Given that Stock A is correctly priced, we can use its information to find the Market Return. For Stock A: 13.2% = 5.5% + 1.4 * (Market Return - 5.5%). Solving for Market Return gives us 10.5%. Using this Market Return for Stock B: Expected Return = 5.5% + 1.25 * (10.5% - 5.5%) = 12.375%, which rounds to 12.38%.

Stock a Is a Risky Asset That Has a Beta