n-f be true, according to the CAPM? A. If the expected rate of inflation increas

Question

n-f be true, according to the CAPM? A. 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. Stock Y's return has a higher standard deviation than Stock X. B. It the market risk premium declines, but the risk-free rate is unchanged, Stock X will have D. E. a larger decline in its required return than will Stock Y Stock Y's realized return during the coming year will be higher than Stock X's return 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

Explanation / Answer

A.

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. The risk free rate is based on inflation. Thus if the inflation increases the risk free rate also increases. Since it is given that market premium remains the same, both stocks will increase by the same change in risk free rate which is based on inflation.

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