Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%.Portfolio X has an expected return of 14% and a beta of 1.00.Portfolio Y has an expected return of 9.5% and a beta of 0.25.In this situation,you would conclude that portfolios X and Y _________.
A) are in equilibrium
B) offer an arbitrage opportunity
C) are both underpriced
D) are both fairly priced

Question

Quizplus · Accepted Answer

Portfolio X has a higher expected return than portfolio Y, but it also has a higher beta. The CAPM suggests that the expected return of a portfolio should be equal to the risk-free rate plus a risk premium that is proportional to the portfolio's beta. In this case, the expected return of portfolio X is 14%, which is equal to the risk-free rate of 8% plus a risk premium of 6%. The expected return of portfolio Y is 9.5%, which is equal to the risk-free rate of 8% plus a risk premium of 1.5%. The difference in risk premiums is due to the difference in betas. Portfolio X has a beta of 1.00, which means that it is expected to move in line with the market. Portfolio Y has a beta of 0.25, which means that it is expected to be less volatile than the market. As a result, portfolio X has a higher risk premium than portfolio Y.

Assume That Both X and Y Are Well-Diversified Portfolios and the Risk-Free