Question

"The risk-free rate of return is 4 percent, and the market return is 10 percent. The betas of Stocks A, B, C, D, and E are 0.85, 0.95, 1.20, 1.35, and 0.5, respectively. The expected rates of return for Stocks A, B, C, D, and E are 8 percent, 9 percent, 10 percent, 14 percent, and 6 percent, respectively. Which stock should a rational investor purchase"?

Answer 1

Answer:

Capm= RF+B(RM-RF)

Capm required return Stock A= 0.04+(0.85*0.06)=0.091=9.1%

9.1% is more than the expected 8 percent return which means that the investor should not buy this security as expected return is less than required return

Capm required return Stock B=0.04+(0.95*0.06)=0.097=9.7%

9.7%  is more than the expected 9 percent return which means that the investor should not buy this security as expected return is less than required return

Capm required return Stock C=0.04+(1.2*0.06)=0.112=11.2%

11.2 percent is more than the expected 10 percent return which means that the investor should not buy this security as expected return is less than required return

Capm required return Stock D=0.04+(1.35*0.06)=0.121=12.1%

12.1% is less than the 14 percent expected return which means that the investor should buy this security as expected return is more than required return.

Capm required return Stock E=0.04+(0.5*0.06)=0.07=7%

7 percent is more than the expected 6 percent return which means that the investor should not buy this security as expected return is less than required return

Explanation: