Copyright

You expect the inflation rate to be 5.2% and the U.S. Treasury bill yield to be 6.5% for the next...

Question:

You expect the inflation rate to be 5.2% and the U.S. Treasury bill yield to be 6.5% for the next year. You also expect the risk premium on small-company stocks to be 3.2% for the year.

What rate of return do you expect to earn on small-company stocks over the next year?

A. 3.3%

B. 8.4%

C. 9.7%

D. 11.7%

E. 14.9%

Risk Premium:

The risk premium of a risky asset is the expected return on the asset in excess of the risk free rate. Thus, the risk premium indicates the amount of returns earned because of risk-bearing. In the capital asset pricing model, an asset's risk premium is the product of its beta and the market risk premium.

Answer and Explanation:

The answer is C.

The risk premium is by definition calculated as follows:

  • risk premium = expected return - risk free rate

The US Treasury bill yield is usually used as an approximate the risk free rate, which is 6.5%. We also know that the risk premium is 3.2%, thus we have:

  • 3.2% = expected return on small-company stocks - 6.5%
  • expected return on small-company stocks = 9.7%

Learn more about this topic:

Loading...
How to Calculate Risk Premium: Definition & Formula

from Financial Accounting: Help and Review

Chapter 5 / Lesson 26
12K

Related to this Question

Explore our homework questions and answers library