Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRF. Meanwhile, investors are afraid of a recession, so the market risk premium, (rM - rRF), has increased. Under these conditions, with other things held constant, which of the following statements is most correct and why?
1. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0.
2. The prices of all stocks would decline, but the decline would be greatest for the highest-beta stocks.
3. The prices of all stocks would increase, but the increase would be greatest for the highest-beta stocks.
4. The required return on all stocks would increase by the same amount.