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Capital Asset Pricing Model Questions

Consider the following information:

Stock A Stock B T-bills
Beta 0.6 1.2 0.0
Expected return, % 5.0 8.0 2.0

(a) Assuming that all stocks are priced correctly according to the CAPM, compute the expected return on the market portfolio.

(c) Is it possible for a stock to have a negative standard deviation in returns? Explain.

(d) Consider two separate stocks: the returns on the stock of AppleCo have a standard deviation of 32% and a beta of 0.9; the returns on the stock of BananaCo have a standard deviation of 20% and a beta of 1.2. Which company's stock should provide a greater return to investors? Why?

All work and formulas are needed to understand the logic behind. Thank you!

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Solution Summary

The article addresses common introductory finance questions regarding the Capital Asset Pricing Model, Sharpe Ratios, and expected returns of stocks.