Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements MUST be true, according to the CAPM?
A) Stock Y's return during the coming year will be higher than Stock X's return.
B) If expected inflation increases but the market risk premium is unchanged, the required returns on the two stocks will increase by the same amount.
C) Stock Y's return has a higher standard deviation than Stock X.
D) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

Question

Quizplus · Accepted Answer

According to the CAPM, the required return on a stock is equal to the risk-free rate plus the product of the stock's beta and the market risk premium. Therefore, if expected inflation increases but the market risk premium is unchanged, the required returns on the two stocks will increase by the same amount. The CAPM does not make any definitive statements about which stock will have a higher return or standard deviation, or which stock will have a larger decline in required return if the market risk premium declines.

Stock X Has a Beta of 0