Which one of the following should earn the most risk premium based on CAPM?
A)diversified portfolio with returns similar to the overall market
B)stock with a beta of 1.38
C)stock with a beta of 0.74
D)U.S. Treasury bill
E)portfolio with a beta of 1.01

Question

Quizplus · Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the expected return of a security is equal to the risk-free rate plus the security's beta multiplied by the market risk premium. As the beta of a security increases, so does its risk premium. Therefore, the stock with a beta of 1.38 should earn the most risk premium compared to the other options, as it has higher systematic risk. The diversified portfolio and the portfolio with a beta of 1.01 have returns similar to the overall market, so their risk premiums should be lower than the stock with a higher beta. The stock with a beta of 0.74 should have a lower risk premium than the market due to its lower systematic risk. The U.S. Treasury bill is considered virtually risk-free, so it should earn the risk-free rate with no risk premium.

Which One of the Following Should Earn the Most Risk