Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM -rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?
A) the required return would decrease by the same amount for both stock a and stock b.
B) the required return would increase for stock a but decrease for stock b.
C) the required return on portfolio p would remain unchanged.
D) the required return would increase for stock b but decrease for stock a.
E) the required return would increase for both stocks but the increase would be greater for stock b than for stock a.

Question

Quizplus · Accepted Answer

The required return on a stock is calculated using the Capital Asset Pricing Model (CAPM): r = rRF + beta * (rM - rRF). An increase in the market risk premium (rM - rRF) will increase the required return for both stocks, but the increase will be greater for Stock B because it has a higher beta (1.2) compared to Stock A (0.8).

Stock a Has a Beta of 0