The risk-free rate of return is 5 percent, and the market return is 8 percent. The betas of Stocks A, B, C, D, and E are 0.75, 0.50, 0.25, 1.50, and 1.25, respectively. The expected rates of return for Stocks A, B, C, D, and E are 8 percent, 6.5 percent, 7 percent, 11 percent, and 7 percent, respectively. Suppose an investor holds all of these stocks in a single portfolio. Based on the information given here, if the investor wants to sell one of the stocks so that only four stocks remain in the portfolio, which stock should be sold?
A)Stock A
B)Stock B
C)Stock C
D)Stock D
E)Stock E

Question

Quizplus · Accepted Answer

Stock E should be sold because its expected return (7%) is lower than the return predicted by the Capital Asset Pricing Model (CAPM), which is 8.75% (5% + 1.25*(8%-5%)).

The Risk-Free Rate of Return Is 5 Percent, and the Market