Stock A has a beta = 1.5, while Stock B has a beta = 0.5. Which of the following

Question

Stock A has a beta = 1.5, while Stock B has a beta = 0.5. Which of the following statements is CORRECT? If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. If the marginal investor becomes less risk averse, the required return on Stock A will increase equally with the required return on Stock B. If the risk-free rate increases but the market risk premium remains constant, the require return on Stock A will increase by less than that on Stock B. None of the above. Engler Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?

Explanation / Answer

Answer

a.If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

Answer 2.

        rs = rRF + RPM

12.50% = 5.25% + RPM

   RPM = 7.25%

Use SML to determine the firm’s required return using RPM calculated above.

rs = rRF + RPM × b

   = 5.25% + (7.25% × 0.88)

   = 11.63%

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