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IAI Actuarial Core Principles · Business Finance · Key principles of finance

Which of the following changes would, other things equal, increase the required return on a company's equity under CAPM?

A rise in equity beta increases the required return. CAPM prices only systematic risk through beta multiplied by the market risk premium, so more beta means a higher required return, while specific risk and a lower premium do not raise it.

  1. AA rise in the company's equity betaCorrect
  2. BA fall in the market risk premium
  3. CA fall in the company's specific (unsystematic) risk
  4. DA fall in the risk-free rate with unchanged market return premium
  5. A reduction in the volatility of the company's dividends only because of diversification

Explanation

Required return = Rf + β(Rm − Rf). A higher beta raises it when the premium is positive. A lower premium reduces it, specific risk is not priced, and a lower risk-free rate with the premium unchanged lowers the required return.

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