Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?
A. The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
B. The required rate of return will decline for stocks whose betas are less than 1.0.
C. The required rate of return on the market, rM, will not change as a result of these changes.
D. The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium.
E. The required rate of return on a riskless bond will decline.
Answer: A
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