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The annual returns for stock A have a standard deviation of 40%, and the stock’s beta is 1.2. The annual returns for stock B have a standard deviation of 60%, and the stock’s beta is 0.9. Which stock would have a higher expected return? Why?

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beritop1089

Answer:

Stock A

Explanation:

Even though Stock A has a lower standard deviation, it has a higher beta than B. Higher beta stock  has more risk than the market which has a beta of 1.0 and low-beta securities has less risk which is characterized by stock B.  Beta basically measures volatility of returns in relation to the market. Because investors will take on more risk on stock A, they will earn higher expected return than those who invest in stock B.

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