Suppose That Federal Reserve Actions Have Caused an Increase in the Risk-Free

question 109

Multiple Choice

Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRFMeanwhile, investors are afraid of a recession, so the market risk premium, (rM - rRF) , has increased Under these conditions, with other things held constant, which of the following statements is most correct?

• A) The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0.
• B) Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices.
• C) The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.
• D) The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.
• E) The required return on all stocks would increase by the same amount.

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Definitions:

Reinvestment Assumptions

Reinvestment assumptions pertain to the conditions under which profits or returns from an investment are assumed to be reinvested to generate additional earnings.

Internal Rate

An abbreviation for Internal Rate of Return; a metric used in financial analysis to estimate the profitability of potential investments.

Net Present Value

A calculation used to assess the profitability of an investment by determining the difference between the present value of cash inflows and outflows.

Incremental Cash Flows

Additional cash flows from taking on a new project, crucial for analysis in capital budgeting decisions to determine a project's potential profitability.