Suppose that during the coming year, the risk free rate, r_RF, is expected to remain the same, while the market risk premium (r_M − r_RF), is expected to fall.Given this forecast, which of the following statements is CORRECT? A) The required return on all stocks will remain unchanged. 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. E) 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.

Question

Quizplus · Accepted Answer

The required return on stocks is determined by the Capital Asset Pricing Model (CAPM), which states that the expected return on a security equals the risk-free rate plus the product of the security's beta and the market risk premium. If the market risk premium decreases while the risk-free rate remains constant, the required return on all stocks will decrease. However, because the decrease is multiplied by the beta, stocks with higher betas will see a larger decrease in their required returns.

Suppose That During the Coming Year, the Risk Free Rate