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, rM, 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.

Question

Quizplus · Accepted Answer

When investors become more risk averse, the market risk premium increases, which leads to an increase in the required rate of return for an average stock. The required rate of return for a riskless bond is not affected by changes in the market risk premium. The required rate of return on the market may change, but this is not stated in the question. The required rate of return for individual stocks will increase by varying amounts depending on their betas, not by an amount equal to the increase in the market risk premium. Therefore, Option E is the most likely outcome.

Assume That Investors Have Recently Become More Risk Averse, So