Question

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?
The required return on a stock with beta = 1.0 will not change.
The required return on a stock with beta > 1.0 will increase.
The return on "the market" will remain constant.
The return on "the market" will increase.
The required return on a stock with beta < 1.0 will decline.

pzl explain why,tks

Answer 1

required return = risk free rate + (beta * (market return - risk free rate))

"(market return - risk free rate)" is called the market risk premium

The correct answer is - The required return on a stock with beta < 1.0 will decline. This is because the risk free rate is constant, but the market risk premium has declined.

Option 1 is incorrect - The required return will decrease due the decline in market risk premium

Option 2 is incorrect - The required return will decrease due the decline in market risk premium

Option 3 is incorrect - The return on the market will decrease, since the the risk free rate is constant, but the market risk premium has declined.

Option 4 is incorrect - The return on the market will decrease, since the the risk free rate is constant, but the market risk premium has declined.