Assume that the risk-free rate, r_RF, increases but the market risk premium, (r_M − r_RF), declines, with the net effect being that the overall required return on the market, r_M, remains constant.Which of the following statements is CORRECT? A) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. B) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. C) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. D) The required return of all stocks will fall by the amount of the decline in the market risk premium. E) The required return of all stocks will increase by the amount of the increase in the risk-free rate.

Question

Quizplus · Accepted Answer

The decrease in market risk premium results in a lower required return, which benefits stocks with higher beta. However, the increase in risk-free rate raises the required return, which disproportionately affects stocks with lower beta. As a result, the overall effect of the changes is an increase in required return for low-beta stocks and a decrease in required return for high-beta stocks. Therefore, the correct answer is C.

Assume That the Risk-Free Rate, RRF, Increases but the Market

Assume That the Risk-Free Rate, R_RF, Increases but the Market