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 become convinced that there will 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 stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
E) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount,then the required rate 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 on an average stock (which typically has a beta of 1) remains unchanged if both the risk-free rate and the market risk premium change by the same amount but in opposite directions, according to the Capital Asset Pricing Model (CAPM). Stocks with betas less than 1.0 are less sensitive to market movements, so if the risk-free rate increases and the market risk premium decreases by the same amount, their required returns do not necessarily rise as indicated in the choice. This explanation corrects the misinterpretation in choice E, making it technically incorrect as stated, but it's based on a misunderstanding of how CAPM works. The correct understanding is that changes in the risk-free rate and market risk premium affect required returns based on the stock's beta, but not in the simplistic way described in any of the options.

Which of the Following Statements Is CORRECT