Aziz Equipment Co. invests in a group of risky projects, which increases the unsystematic risk of the ﬁrm, but does not change the systematic risk of the ﬁrm. All else the same, the expected risk
Premium on its common stock is most likely to:
A) Increase, because the difference between the expected return on the ﬁrm's stock and the risk-free rate will widen.
B) Decrease, because the difference between the expected return on the ﬁrm's stock and the risk-free rate will narrow.
C) Remain unchanged, because the level of systematic risk is unchanged.
D) Increase or decrease, depending on the internal rate of return of the new projects.
E) Decrease, because the difference between the expected return on the ﬁrm's stock and the risk-free rate will widen.

Question

Quizplus · Accepted Answer

The expected risk premium on a stock is determined by its systematic risk, not unsystematic risk. Since the systematic risk remains unchanged, the risk premium remains unchanged.