During the next year, the market risk premium, (rM - rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is correct?
A) The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
B) The required return will fall for all stocks, but it will fall MORE for stocks with higher betas.
C) The required return for all stocks will fall by the same amount.
D) The required return will fall for all stocks, but it will fall LESS for stocks with higher betas.

Question

Quizplus · Accepted Answer

The required return is calculated using the Capital Asset Pricing Model (CAPM): r = rRF + β(rM - rRF). If the market risk premium (rM - rRF) decreases and the risk-free rate (rRF) remains the same, the required return will decrease for all stocks. However, the decrease will be more significant for stocks with higher betas because the impact of the change in the market risk premium is amplified by the beta.

During the Next Year, the Market Risk Premium, (RM -