Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?
A) if both expected inflation and the market risk premium (rm - rrf) increase, the required return on stock hb will increase by more than that on stock lb.
B) if both expected inflation and the market risk premium (rm - rrf) increase, the required returns of both stocks will increase by the same amount.
C) since the market is in equilibrium, the required returns of the two stocks should be the same.
D) if expected inflation remains constant but the market risk premium (rm- rrf) declines, the required return of stock hb will decline but the required return of stock lb will increase.
E) if expected inflation remains constant but the market risk premium (rm - rrf) declines, the required return of stock lb will decline but the required return of stock hb will increase.

Question

Quizplus · Accepted Answer

The required return on a stock is influenced by its beta. A higher beta means the stock is more sensitive to changes in the market risk premium. Therefore, if both expected inflation and the market risk premium increase, the required return on Stock HB (with a higher beta of 1.5) will increase more than that on Stock LB (with a lower beta of 0.5).

Stock LB Has a Beta of 0