Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?
A) The required return of all stocks will increase by the amount of the increase in the risk-free rate.
B) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.
C) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.
D) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.

Question

Quizplus · Accepted Answer

When the risk-free rate increases and the market risk premium decreases, stocks with a beta less than 1.0 will see an increase in required return, while stocks with a beta greater than 1.0 will see a decrease, as the change in risk-free rate affects them differently based on their beta.

Assume That the Risk-Free Rate, RRF, Increases but the Market