The risk-free rate, rRF, is 6 percent and the market risk premium, (rM - rRF), is 5 percent. Assume that required returns are based on the CAPM. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is most correct?
A) The portfolio's required return is less than 11 percent.
B) If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points.
C) If the market risk premium remains unchanged but expected inflation increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points.
D) If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11 percent.
E) None of the above answers is correct.

Question

Quizplus · Accepted Answer

The portfolio beta is 1.08, calculated as (0.7 * 1.2) + (0.3 * 0.8). The initial required return is 11.4% using CAPM: 6% + 1.08 * 5%. If the market risk premium increases by 2%, the new required return is 13.56%, an increase of more than 2 percentage points.

The Risk-Free Rate, RRF, Is 6 Percent and the Market