Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5.The market is in equilibrium,with required returns equalling expected returns.Which of the following statements is correct? A)If expected inflation remains constant but the market risk premium (r_M - r_RF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. B)If both expected inflation and the market risk premium (r_M - r_RF) increase, the required return on Stock HB will increase by more than that of Stock LB. C)If both expected inflation and the market risk premium (r_M - r_RF) increase, the required returns of both stocks will increase by the same amount. D)If expected inflation remains constant but the market risk premium (r_M - r_RF) declines, the required return on Stock HB will decline but the required return of Stock LB will increase.

Question

Quizplus · Accepted Answer

The required return on a stock is influenced by both the risk-free rate (which is affected by inflation) and the market risk premium. Since Stock HB has a higher beta (1.5) compared to Stock LB (0.5), it 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 will increase more than that of Stock LB due to its higher sensitivity to market changes.

Stock HB Has a Beta of 1