Suppose that Federal Reserve actions are steadily causing an increase in the ris
ID: 2813106 • Letter: S
Question
Suppose that Federal Reserve actions are steadily causing an increase in the risk-free rate, r_RF.Meanwhile, investors are afraid of a recession, so the market risk premium, (r_M - r_RF), has increased.
Under these conditions, with other things held constant, which of the following statements is most correct? A. Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. B. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. C. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. D. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. E. The required return on all stocks would increase by the same amount. Suppose that Federal Reserve actions are steadily causing an increase in the risk-free rate, r_RF.
Meanwhile, investors are afraid of a recession, so the market risk premium, (r_M - r_RF), has increased.
Under these conditions, with other things held constant, which of the following statements is most correct? A. Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. B. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. C. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. D. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. E. The required return on all stocks would increase by the same amount.
Explanation / Answer
As per CAPM return on stocks = Risk free rate + beta * Market risk premium
a) Option a Is incorrect beacuse when risk free rate and market risk premium changes then rice of stock will change as per above formula.
b) Option b is correct bacuse higher beta stocks will have increases with respect to increase in market risk premium.
c) Opton c is incorrect becuse return or prices will not decrease ut increase
d) option d is incorrect beacuse low beta stocks the increase will be less as compared to high beta stocks.
e)The increase will not be in same amount due to diffferenrt beta.Option e is incorrect
Only option b is correct
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