Assume That the Risk-Free Rate,r_RF,increases but the Market Risk Premium

question 131

Multiple Choice

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

• A) The required return of all stocks will increase by the amount of the increase in the risk-free rate.
• B) 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.
• C) Since the overall return on the market stays constant,the required return on each individual stock will also remain constant.
• D) 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.
• E) The required return of all stocks will fall by the amount of the decline in the market risk premium.

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Definitions:

Owner's Equity

The residual interest in the assets of an entity after deducting liabilities, representing the owner's claim on the business assets.

Intangible Assets

Assets having no physical substance (such as patents or franchises).

Current Assets

Assets that are expected to be converted into cash, sold, or consumed during the next 12 months or within the business's normal operating cycle if longer.

Prepaid Insurance

A current asset account that represents the amount of insurance premiums paid in advance for coverage extending beyond the current accounting period.