When Treasury yields increased recently, we observed that stock prices generally declined and that hi-tech stocks slumped much more than cyclical stocks. The folloiwng statements attempt to explain these phenomena. 1) Treasury yields measure the risk-free return. The required return on a risky asset such as a stock is the sum of the risk-free rate and the risk premium on the risky asset. When the risk-free rate increases, so does the required return on a stock. Because a stock's value is the present value of future cash flows, this value will be lower when the required return (used as the discount rate in the present value calculation) is higher. 2) When the discount rate increases, the present value of cash flows occuring in the far future drops more severely than the present value of cash flows occurring in the near future does, simply because of the greater power term in the denomintor associated with times farther in the future. Although hi-tech firms may not generate decent cash flows in the near future, people anticipate them to generate large cash flows in the farther future based in their growth potential (think of Tesla). This is why hi-tech firm's stock prices tend to drop more than cyclical stocks when the discount rate increases. 3) An increase in Treasury yields means investors are chasing Treasury bonds and pushing their prices up. When investors' interest and money move to the bond market, the stock market suffers and stock prices drop.

4) Higher Treasury yields indicate higher borrowing costs in the bond market. Higher bond yields hurt hi-tech firms more than cyclical firms because hi-tech firms usually borrow more in the bond market than cyclical firms.

Which statement(s) are correct?

A.

1 and 2

B.

4 and 1

C.

3 and 4

D.

2 and 3