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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.
(b) Stocks are generally regarded as being risky investments. According to the CAPM, is it possible for a stock to have an expected return that is less than the risk-free rate? Explain.
(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 who hold well-diversified portfolios? Why?
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