Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur? A)The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. B)The required rate of return will decline for stocks whose betas are less than 1.0. C)The required rate of return on the market, r_M, will not change as a result of these changes. D)The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium.

Question

Quizplus · Accepted Answer

An increase in the market risk premium will lead to an increase in the required rate of return for all stocks, including the average stock. This is because the market risk premium is a key component of the overall required rate of return for any stock. Therefore, (A) is the most likely outcome. Choices (B) and (D) are not necessarily true because they assume that the betas or required rates of return for individual stocks will change, which may not necessarily be the case. Choice (C) is not true because an increase in the market risk premium would lead to an increase in the required rate of return on the market portfolio.

Assume That Investors Have Recently Become More Risk Averse,so the Market