Assume that the risk-free rate is 2%, the market risk premium is 5%, and the beta of two stocks a and b are 1.4 and 0.8 respectively

a. Calculate both stocks's required rates of return

b. What would be the return on an "average" stock?

c. Explain the significance of a security with a 0 beta. what would be this security's required return?

d. Assume the economy worsens and the investors correspondingly revise their attitudes towards stocks. would this change be better reflected in a shift in the market risk premium to 3.5% or 6.5%?

e. based on your answer to (d) what would be the new required return for stock A and B? would you expect the stock prices for A and B to fall or rise?

f. Ignoring (d) and (e) above, assume that inflationary expectation were revised upwards by 0.5%. what would be the change to required returns for stocks A and B? would their prices fall or rise?