3b) In addition, the price of U.S. stocks falls and their risk premium rises .

Question

BlackTom AI · Accepted Answer

The provided item appears to be incomplete for a multiple-choice format because there are no answer options to evaluate.
Nonetheless, we can analyze the two terms present in the stem and the implied relationship between them.
First, consider the phrase: 'the price of U.S. stocks falls.' In general, a fall in stock prices implies higher expected returns on those stocks when prices are lower, assuming cash flows are unchanged or expectations of future payouts are not dramatically worse. Investors may require or demand higher returns to hold riskier equities, which is tied to discounting future cash flows at higher required yields.
Next, the phrase: 'their risk premium rises.' The risk premium is typically defined as the extra return above the risk-free rate that investors demand to compensate for risk. A rise in the risk premium can occur if investors become more risk-averse, if the risk-free rate falls while the expected return on stocks does not rise as much, or if perceived equity risk increases, leading to a higher compensation for bearing risk.
Now, connecting the two parts: if stock prices fall and the risk premium rises, this could reflect a scenario where prices drop (pushing up required returns) while the baseline risk-free rate or risk assessment shifts in a way that increases the premium investors demand beyond the risk-free rate. Conversely, if the risk premium rises while prices fall, it suggests that investors view equities as riskier relative to a lower or unchanged risk-free rate, reinforcing the higher compensation over the risk-free return.
If instead the risk premium did not rise when prices fell, we might expect the drop in price to be explained by a decline in expected returns or a re-pricing due to changes in risk perceptions that offset the move in prices. In such cases, one would need to know the exact relationship between price changes, expected returns, and the risk-free rate to determine consistency.
Because there are no answer options to critique here, we cannot label any choice as correct or incorrect. However, understanding these relationships helps in evaluating any future statements: look for whether a fall in stock prices is paired with a higher risk premium, and whether the implied math (risk premium = expected return − risk-free rate) actually supports that combination given the context.

2025Fall-ECN3615-01 Practice Final Exam

3b) In addition, the price of U.S. stocks falls and their risk premium rises .

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