Which of the following statements is correct?
A)If a firm's stockholders are well diversified, we know from theory and from studies of market behavior that corporate risk is not important.
B)Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk.
C)Empirical studies of the determinants of required rates of return (k) have found that only market risk affects stock prices.
D)Market risk is important but does not have a direct effect on stock price because it only affects beta.

Question

Quizplus · Accepted Answer

Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk. This is because the risk of bankruptcy or financial distress of the individual firm is a major concern for these stockholders. Theory and empirical evidence also suggest that corporate risk does play a role in determining required rates of return and stock prices. Option A is incorrect because corporate risk is still important for well-diversified stockholders, even though they are less exposed to it compared to undiversified stockholders. Option C is incorrect because empirical studies have found that both market risk and corporate risk affect required rates of return and stock prices. Option D is incorrect because market risk can directly affect stock price through changes in discount rates, which ultimately affect stock prices.

Which of the Following Statements Is Correct