Question

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant? a. The required return on Portfolio P would remain unchanged. b. The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. OC. The required return on Portfolio P would increase by 1%. d. The required return on both stocks would increase by 1%. Oe. The required return for Stock A would fall, but the required return for Stock B would increase

Answer 1

Required return = risk free rate + (beta * market risk premium)

Beta of portfolio = weighted beta of stocks in portfolio = (50% * 0.7) + (50% * 1.3) = 1.00

The answer is (c). The required return of the portfolio would increase by 1% because the beta of the portfolio is 1

(a) will not occur. The required return of the portfolio would increase

(b) will not occur. The required return of Stock A would increase by less than 1% as its beta is less than 1. The required return of Stock B would increase by morethan 1% as its beta is more than 1.

(d) will not occur. The required return of Stock A would increase by less than 1% as its beta is less than 1. The required return of Stock B would increase by morethan 1% as its beta is more than 1.

(e) will not occur. The required return of both stocks would increase