Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?
A) If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2- stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
B) Stock Y's realized return during the coming year will be higher than Stock X's return.
C) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
D) Stock Y's return has a higher standard deviation than Stock X.

Question

Quizplus · Accepted Answer

According to the CAPM, the required return on a stock is equal to the risk-free rate plus the product of the stock's beta and the market risk premium. If the expected rate of inflation increases but the market risk premium remains unchanged, the risk-free rate would increase but the market risk premium would not change. As a result, the required return on each stock should increase by the same amount since the beta of each stock is the only difference in their required returns. Therefore, choice C is the correct answer. Choices A and D are false statements, and choice B cannot be determined solely by the information given.

Stock X Has a Beta of 0