Stock HB Has a Beta of 1

question 105

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 (r_M - r_RF)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 (r_M - r_RF)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 (r_M - r_RF)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 (r_M - r_RF)declines,the required return of Stock HB will decline but the required return of Stock LB will increase.

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Definitions:

FTSE

An acronym for the Financial Times Stock Exchange, referring to major stock market indices such as the FTSE 100 in the United Kingdom.

Put Option

An economic arrangement allowing the holder the option, without being compelled, to sell a designated quantity of an underlying asset at an agreed-upon price within a defined period.

Exercise Price

The price at which the holder of an options contract may buy (in the case of a call) or sell (in the case of a put) the relevant security or commodity.

Expiration Date

In finance, the date at which a derivative contract such as an option or futures agreement ceases to exist.