Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?
A) The required return on both stocks would increase by 1%.
B) The required return on Portfolio P would remain unchanged.
C) The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.
D) The required return for Stock A would fall, but the required return for Stock B would increase.
E) The required return on Portfolio P would increase by 1%.

Question

Quizplus · Accepted Answer

The required return on a portfolio is the weighted average of the required returns on the individual assets in the portfolio, with the weights being the proportions of the portfolio invested in each asset. In this case, Portfolio P has 50% invested in both Stock A and Stock B, so the required return on Portfolio P is the average of the required returns on Stock A and Stock B. If the market risk premium increases by 1% but the risk-free rate remains constant, then the required return on both Stock A and Stock B will increase by 1%. This is because the market risk premium is the difference between the expected return on the market and the risk-free rate, and if the market risk premium increases, then the expected return on the market must also increase. Since the required return on a stock is the sum of the risk-free rate and the market risk premium multiplied by the stock's beta, if the market risk premium increases, then the required return on the stock will also increase. Therefore, the required return on Portfolio P will also increase by 1%.

Stock a Has a Beta of 0