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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!

Solution Summary

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