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

Question

Quizplus · Accepted Answer

The required return on a stock is determined by the capital asset pricing model (CAPM), which takes into account the risk-free rate, the market risk premium, and the stock's beta. In this scenario, the risk-free rate is constant, but the market risk premium increases, which means that the required return on both stocks will increase. However, because Stock B has a higher beta than Stock A, the increase in required return will be greater for Stock B. Therefore, the best choice is A. The required return on Portfolio P will also increase, but by a weighted average of the required returns on Stock A and Stock B.

Stock a Has a Beta of 0