Question

Suppose that in year 2030, investors become much more willing than before to bear risk. As a result, they require a return of 8% to invest in common stocks rather than the 10% that they had required in the past. This shift in risk aversion causes a 15% change in the value of the market portfolio.

a. Do stock prices rise by 15% or fall? Rise by 15% or Fall by 15%

Answer 1

The Correct answer is Rise by 15%

The required return refers to the return that the shareholders expect from the investment, when the required return of the common shareholders falls then it means company has to distribute less amount of earnings in form of dividends and can retain larger portion of earnings, This impact will lead to Higher earning per share thus leading to increase share price of the stock. When the share price increases the market capitalisation of the company rises. Therefore, the correct answer is it will rise by 15%.