A. If the risk-free rate increases but the market risk premium remains unchanged

Question

A. If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta.

B. If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0.

C. Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's.

D. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

E. If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0.

Explanation / Answer

  D. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

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