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Riskier Stock

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A. Common stock A has an expected return of 10%, a standard deviation of future returns of 25%, and a beta of 1.25. Common stock B has an expected return of 12%, a standard deviation of future returns of 15%, and a beta of 1.50. Which stock is riskier? Explain.

b. Suppose rf is 5% and rM is 10%. According to the SML and the CAPM, an asset with a beta of 2.0 has a required return of negative 5% .Can this be possible? Does this mean that the asset has negative risk? Why would anyone ever invest in an asset that has an expected and required return that is negative? Explain.

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Solution Summary

The solution evaluates two questions and provides brief explanation for both the questions. The solution evaluates riskier stocks based on the concept of CAPM. The answers are very well explained. Overall, an excellent response to the question.

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a. The stock with the higher Beta of 1.5 has the higher risk (B). Standard deviation measure the total risk of a stock and not the market risk. Total risk consists of risks that can ...

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