Stocks A, B and C have betas of 0.8, 1.0, and 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stock is zero. If market is in equilibrium, which of the following is correct?
A) Portfolio P's expected return is greater than the expected return on Stock B.
B) Portfolio P's expected return is equal to the expected return on Stock A.
C) Portfolio P's expected return is less than the expected return on Stock B.
D) Portfolio P's expected return is equal to the expected return on Stock B.

Question

Quizplus · Accepted Answer

The expected return of a portfolio is determined by the weighted average of the expected returns of the individual stocks, which is influenced by their betas. Since Portfolio P has an average beta of 1.0 (the same as Stock B), its expected return is equal to the expected return on Stock B in a market equilibrium.

Stocks A, B and C Have Betas of 0