Nile Foods’ stock has a beta of 1.4

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Nile Foods’ stock has a beta of 1.4, while Elbe Eateries’ stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM – rRF), equals 4%. Which of the following statements is CORRECT?Since Nile’s beta is twice that of Elbe’s, its required rate of return will also be twice that of Elbe’s. 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. 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 Elbe’s will decline because it has a beta less than 1.0. 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 Elbe’s will also decrease, and by more than Nile’s because it has a beta less than 1.0. 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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