Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur? A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta

Question

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?
A) The required return on a stock with beta = 1.0 will not change.
B) The required return on a stock with beta > 1.0 will increase.
C) The return on "the market" will remain constant.
D) The return on "the market" will increase.
E) The required return on a stock with a positive beta < 1.0 will decline.

Quizplus · Accepted Answer

The required return on a stock is calculated as the risk-free rate plus the product of the market risk premium and the stock's beta. If the market risk premium declines, the required return on a stock with a positive beta (which measures the stock's sensitivity to market movements) should decline as well. The other options are incorrect because they do not take into account the effect of beta on required return, or assume changes in the market return that are not specified in the question.

Assume That the Risk-Free Rate Remains Constant,but the Market Risk