If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing ________ and ________.
A) expected returns to fall; risk premiums to fall
B) expected returns to rise; risk premiums to fall
C) expected returns to rise; risk premiums to rise
D) expected returns to fall; risk premiums to rise

Question

Quizplus · Accepted Answer

When investors buy stocks in large numbers, demand for those stocks increases, which drives up their prices. As prices rise, the future returns investors can expect from those stocks decrease because they are buying at higher prices. Similarly, as stock prices rise and become more expensive relative to their expected future cash flows, the additional return (or risk premium) investors require to invest in stocks over risk-free assets also falls, as the perceived risk decreases with higher prices and more investor interest.

If Enough Investors Decide to Purchase Stocks, They Are Likely