Final answer:
Investors expect a higher expected return when investing in levered firms due to the increased risk from the firm's debt obligations.
Step-by-step explanation:
An investor who invests in the stock of a levered firm rather than in an all-equity firm will require a higher expected return. This is because levered firms take on debt, which introduces additional risk to the investor. In exchange for bearing this higher risk, investors typically expect a higher rate of return. If a firm only issues stock (all-equity firm), then there is no interest obligation, and insolvency risk is generally lower compared to a levered firm. Therefore, investors would require a higher return when investing in stocks of a levered firm to compensate for the increased risk.