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CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models

Assume the risk-free rate and the market risk premium are unchanged. If the beta of a stock rises from 0.8 to 1.3, the stock's required return under the CAPM will most likely:

The required return will increase as the stock moves up along the security market line. CAPM required return rises linearly with beta when the risk-free rate and market premium are fixed, so higher systematic risk demands higher compensation.

  1. Adecrease because systematic risk has increased
  2. Bincrease along the security market lineCorrect
  3. Cstay the same because total risk is unchanged

Explanation

Required return is linear and increasing in beta, so a higher beta moves the stock up along the SML to a higher required return. The decrease option contradicts the positive risk-return relation. Total risk is irrelevant to CAPM pricing.

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