Assume That the Risk-Free Rate, RRF, Increases but the Market

question 37

Multiple Choice

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF) , declines, with the net effect being that the overall required return on the market, rM, remains constant Which of the following statements is CORRECT?

• A) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.
• B) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.
• C) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.
• D) The required return of all stocks will fall by the amount of the decline in the market risk premium.
• E) The required return of all stocks will increase by the amount of the increase in the risk-free rate.

---

Definitions:

Endowment Fund

A fund where the principal amount is kept intact while the investment income is used for specific purposes, often found in non-profits and educational institutions.

Principal Amount

The initial size of a loan or bond or the amount deposited, excluding any interest or earnings.

Scholarships

Financial aid awarded to students to help pay for education expenses, often based on academic achievement or other criteria.

Restricted Fund Method

An accounting practice used for reporting resources that have been restricted by donors or grantors.