Which of the following statements is correct?
A)If a company's beta doubles, then its required rate of return will also double.
B)Other things held constant, if investors suddenly became convinced that there would be deflation in the economy, then the required returns on all stocks should increase.
C)If a company's beta were cut in half, then its required rate of return would also be halved.
D)If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Question

Quizplus · Accepted Answer

The required rate of return for stocks is calculated using the Capital Asset Pricing Model (CAPM), which includes the risk-free rate and the market risk premium. If the risk-free rate increases but the market risk premium declines by the same amount, the overall required rate of return on an average stock will remain unchanged. However, since the market risk premium has declined, stocks with betas less than 1.0 will have a higher required rate of return, as they will be relatively more risky compared to the market. Option A is incorrect because the required rate of return is not directly proportional to the beta of a company. Option B is incorrect because deflation would decrease the required rate of return on stocks, not increase it. Option C is incorrect because cutting a company's beta in half would not necessarily halve its required rate of return.

Which of the Following Statements Is Correct