The formula for computing the risk premium is the: The formula for computing the risk premium...
The formula for computing the risk premium is the:
The formula for computing the risk premium is the:
| a. |
security's return plus the risk-free rate. |
|
| b. |
expected return plus the risk-free rate. |
|
| c. |
security's return minus the market rate. |
|
| d. |
market rate minus the inflation rate. |
|
| e. |
expected return minus the risk-free rate. |
Homework Answers
The answer is e. "expected return minus the risk-free rate"
In simple words, risk premium is the premium which an investor expects to invest in risky asset. The spread between the risk free rate and risky rate is risk premium. In normal circumstances, risk premium is highest for equity compared to debt or convertibles. Risk free rate is generally the Sovereign bond yield of AAA rates countries. These countries are not expected to default and hence the term, "risk free".
In other words, risk premium is premium charged for probability of default. Thus, riskier the asset, higher the risk premium.
Additionally, widely used CAPM formula also defines the risk premium in the same way.
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The formula for computing the risk premium is the:
The formula for computing the risk premium...
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