Nile Foods’ stock has a beta of 1.5, while Elba Eateries’ stock has a beta of 0.5. Assume that the risk-free rate, rRF, is 6.2% and the market risk premium, (rM– rRF), equals 7%. Which of the following statements is correct?
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If the risk-free rate decreases but the market risk premium remains unchanged, the required return will decrease for both stocks, but the decrease will be larger for Nile since it has a higher beta.
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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 but Elba’s will increase because it has a beta less than 1.0.
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Since Nile’s beta is three times that of Elba’s, its required rate of return will also be three times that of Elba’s.
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If the risk-free rate decreases while the market risk premium remains constant, then the required return on an average stock will decrease.
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