Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of

Question

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is correct?

Which Answer is correct

A) The required returns on all three stocks will increase by the amount of the increase in the market risk premium.

B)The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

C)The required return of all stocks will remain unchanged since there was no change in their betas.

D)The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.

E) The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.

Explanation / Answer

Observe that beta of stock A is 0.8 beta of stock B is 1.0 and beta of stock C is 1.2.

Standard deviation is 25% each.

The return on the stocks is independent of each other.

Observe that part b is correct because beta measures the volatility of the portfolio.

Since the beta of the stock A is less than 1 and beta of stock C is greater than 1, therefore stock A return will increase less than the increase in market premium and stock C return will increase greater than the market premium.

Part e is also correct because the average returns of the risky stocks will increase and the safer stocks will decrease.

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.