Portfolio P Has Equal Amounts Invested in Each of the Three

question 97

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:

Operating Loss Carryforward

A tax provision that allows businesses to apply current year's operating losses to future profits for tax relief.

Taxable Income

Income of an individual or corporation subject to tax by governmental authorities.

Financial Income

Income generated through investments or other financial instruments, distinct from operational or business income.

Deferred Tax Asset

An accounting term representing taxes that have been overpaid or deferred for future periods, potentially reducing future tax liabilities.