Dixon Food's Stock Has a Beta of 1

question 39

Multiple Choice

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate, r_RF, is 5.5% and the market risk premium, (r_M − r_RF) , equals 4%.Which of the following statements is CORRECT?

• A) If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0.
• B) Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's.
• C) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
• D) If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0.
• E) If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.

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Definitions:

Market Equilibrium

Market equilibrium occurs when the quantity demanded of a good matches the quantity supplied, leading to a stable market price where there is no tendency for it to change.

Price Drop

A decrease in the cost of goods or services in the market, often due to supply and demand factors, competition, or other economic elements.

Producer Surplus

The variance between the minimum amount producers are prepared to take for a product or service and the actual price they obtain in the marketplace.

Carpentry Work

The craft or activity of cutting, shaping, and installing wood for buildings, furniture, or other structures.