Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur? A) The required rate of return will decline for stocks whose betas are less than 1.0. B) The required rate of return on the market, r_M, will not change as a result of these changes. C) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk D) The required rate of return on a riskless bond will decline. E) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

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Quizplus · Accepted Answer

When investors become more risk averse, the market risk premium increases. This means that the required rate of return for all stocks in the market will increase by an amount equal to the increase in the market risk premium, as investors will demand a higher return to compensate for the increased risk. Therefore, the answer is E - the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. The other choices are incorrect. The required rate of return will not decline for stocks whose betas are less than 1.0, as they are still subject to market risk. The required rate of return on the market (r_M) will change as a result of these changes, as the market risk premium has increased. The required rate of return on a riskless bond will not decline, as the risk-free rate has not changed.

Assume That Investors Have Recently Become More Risk Averse, So