Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF.Meanwhile, investors are afraid of a recession, so the market risk premium, (rM - rRF), has increased.Under these conditions, with other things held constant, which of the following statements is most correct?

Question

Quizplus · Accepted Answer

The Capital Asset Pricing Model (CAPM) formula, which calculates the expected return on equity or required rate of return, is given by E(Ri) = rRF + βi(rM - rRF). An increase in the risk-free rate, rRF, directly increases the required return on all stocks. Additionally, an increase in the market risk premium, (rM - rRF), also increases the required return, but its impact is magnified for stocks with higher betas. High-beta stocks are more sensitive to market movements, so their prices would decline more significantly as the required return on these stocks increases more sharply.

Suppose That Federal Reserve Actions Have Caused an Increase in the Risk-Free