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Stephanie Dell is evaluating two stocks (X and Y) using the capital asset pricing model. Dell predicts that the betas for the two stocks will be identical but that the unsystematic risk for Stock X will be much higher than for Stock Y. According to the capital asset pricing model, in equilibrium:

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Question:

A
Stock X will have a higher standard deviation than Stock Y but an expected return equal to Stock Y.

explanation

1212The equation for the capital asset pricing model is:

Beta measures the sensitivity of the stock's returns to changes in the returns on the market portfolio and is a standardized measure of the stock's systematic or non-diversifiable risk. As indicated by the CAPM equation, the expected return for any stock is related to its beta. In contrast, unsystematic risk does not affect the CAPM expected return. Therefore, according to the CAPM, expected returns are identical for assets with identical betas. Stock X has identical systematic risk but greater unsystematic risk than Stock Y, resulting in greater total risk (standard deviation).

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