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

Question

Quizplus · Accepted Answer

The required return on a stock is calculated using the Capital Asset Pricing Model (CAPM): r = rRF + beta * (rM - rRF). An increase in the market risk premium (rM - rRF) will increase the required return for both stocks, but since Stock B has a higher beta, the increase will be greater for Stock B than for Stock A.

Stock a Has a Beta of 0