Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 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 stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECTσ
A) portfolio p's expected return is equal to the expected return on stock a.
B) portfolio p's expected return is less than the expected return on stock b.
C) portfolio p's expected return is equal to the expected return on stock b.
D) portfolio p's expected return is greater than the expected return on stock c.
E) portfolio p's expected return is greater than the expected return on stock b.

Question

Quizplus · Accepted Answer

Since the market is in equilibrium, the expected returns of all assets should be proportional to their betas. Stock A has a lower beta than the market, so its expected return should be less than the market's expected return. Stock B has a beta equal to the market, so its expected return should be equal to the market's expected return. Stock C has a higher beta than the market, so its expected return should be greater than the market's expected return. 
Portfolio P has an equal investment in each stock, so its beta is simply the average of the betas of the three stocks, which is (0.8 + 1.0 + 1.2) / 3 = 1. The expected return on portfolio P should therefore be equal to the expected return on the market, which is the expected return on Stock B, since it has a beta equal to the market. Therefore, the answer is C.

Stock a Has a Beta of 0