Stock HB Has a Beta of 1

question 36

Multiple Choice

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

• A) If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.
• B) If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.
• C) If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount.
• D) Since the market is in equilibrium, the required returns of the two stocks should be the same.
• E) If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.

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Definitions:

Long Run

An economic phase where all production elements and expenses can adjust completely, adapting to changes due to their variable nature.

Variable Inputs

Production factors that can be adjusted in the short term to change the level of output, such as labor and raw materials.

Short Run

A period of time in which at least one input in the production process is fixed, influencing decisions made by firms about production levels.

Plant Capacity

Plant capacity refers to the maximum output a manufacturing or production facility can achieve under normal conditions within a given time period.