Question

In an efficient market, the cost of equity for a highly risky firm: In an efficient market, the cost of equity for a highly risky firm: decreases as the beta of the firm's stock increases. will be less than the market rate but higher than the risk-free rate. changes by 1 percent for every 1 percent change in the risk-free rate. must equal the market rate of return. increases in direct relation to the stock's systematic risk.

Answer 1

In an efficient market, the cost of of the firm's equity e. increases in direct relation to the stock's systematic risk.

An efficient market bears these characteristics:

• Perfect, complete, and instant transmission of information
• There is no cost to information.
• Stock prices reflect available information.
• Forecasting cannot help in generating returns.

Thus, in an efficient market, the cost of equity reflects the market's systematic risk.

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