Suppose that Federal Reserve actions have caused an increase in the risk-free rate, r_RF.Meanwhile, investors are afraid of a recession, so the market risk premium, (r_M − r_RF), has increased.Under these conditions, with other things held constant, which of the following statements is most correct? A) The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. B) Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. C) The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. D) The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. E) The required return on all stocks would increase by the same amount.

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Quizplus · Accepted Answer

An increase in the risk-free rate and the market risk premium would increase the required return on all stocks (due to the Capital Asset Pricing Model, CAPM, formula: required return = risk-free rate + beta * (market risk premium)). High-beta stocks are more sensitive to market changes, so their prices would decline more as their required returns increase more significantly.

Suppose That Federal Reserve Actions Have Caused an Increase in the Risk-Free