Portfolio P Has Equal Amounts Invested in Each of the Three

question 137

Multiple Choice

Portfolio P has equal amounts invested in each of the three stocks, A, B, and C.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.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?

• A) 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.
• B) 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.
• C) The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
• D) The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.
• E) The required return of all stocks will remain unchanged since there was no change in their betas.

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Definitions:

Random Error

An unpredictable variation in data or experimental results, which occurs without a discernible pattern.

Systematic Variance

Variability in a set of scores that is the result of the independent variable; statistically, the variability of each group mean from the grand mean of all subjects.

Null Hypotheses

A hypothesis stating there is no significant difference or effect, often denoted as H0, serving as the default assumption to be tested.

Type I Error

An incorrect decision to reject the null hypothesis when it is true.