Security A is expected to return 12% according to CAPM; Security B is expected to return 15% according to CAPM. Which of the following statements is (are)true?
A)Security A must have a higher degree of total risk than Security B.
B)Security B must have a higher degree of market risk than Security A.
C)Security B is a better investment than Security A since it offers a higher return.
D)Both A and C are true.

Question

Quizplus · Accepted Answer

According to CAPM, the expected return of a security is directly related to its market risk, represented by its beta. Thus, Security B, with a higher expected return, must have a higher beta and a higher degree of market risk than Security A. However, we cannot determine which security has a higher degree of total risk (which includes non-systematic risk) based on this information alone. Therefore, statement A is false and statement C cannot be determined. CAPM measures the expected return of an asset based on its systematic risk (market risk), therefore Security B must have a higher degree of market risk than Security A to justify the higher expected return. The statement in option A is false because total risk is composed of both systematic risk and unsystematic risk, which cannot be inferred based solely on the CAPM expected return. The statement in option C is not necessarily true, as the higher expected return of Security B may come with a higher level of risk that some investors may not be willing to take.

Security a Is Expected to Return 12% According to CAPM;