Assume that the risk-free rate remains constant, but the market risk premium declines.Which of the following is most likely to occur? A) The required return on a stock with beta 1.0 will increase. B) The return on "the market" will remain constant. C) The return on "the market" will increase. D) The required return on a stock with beta

Question

Assume that the risk-free rate remains constant, but the market risk premium declines.Which of the following is most likely to occur?
A) The required return on a stock with beta > 1.0 will increase.
B) The return on "the market" will remain constant.
C) The return on "the market" will increase.
D) The required return on a stock with beta < 1.0 will decline.
E) The required return on a stock with beta = 1.0 will not change.

Quizplus · Accepted Answer

When the market risk premium declines, the required return on stocks will generally decrease. This is because the required return on a stock is calculated as the risk-free rate plus the stock's beta times the market risk premium. If the market risk premium decreases, the product of beta times the market risk premium also decreases, leading to a lower required return. This effect is more pronounced for stocks with a beta less than 1.0, as they are considered less risky than the market.

Assume That the Risk-Free Rate Remains Constant, but the Market