Question

If the risk-free rate increases while the expected return to the market portfolio stays the same, then according the the capital asset pricing model ___________.

• A. the expected return to stocks with betas above one will increase, and stocks with betas below one will decrease.
• B. the expected return to stocks with betas above one will decrease, and stocks with betas below one will increase.
• C. the expected return to all stocks, regardless of betas, will decrease.
• D. the expected return to all stocks, regardless of betas, will increase.

Answer 1

Ans.) Correct answer = B. the expected return to stocks with betas above one will decrease, and stocks with betas below one will increase.

Because

E(R) = R_f + β*(E(R_m) - R_f))

So if the Beta value is 1 and E(R_m) is same then there will be no effect on E(R) becasue mathematically R_f gets cancelled out and the return is dependant on market return.

Whereas, if the Beta is greater than 1 and the R_f increases then R_f * Beta will make negative impact on the expected return of stock and vice versa.