Question

Historical stock returns show that small-company stocks produced an average return of 17.4 percent, inflation averaged 3.1 percent, U.S. Treasury bills returned an average 3.8 percent, and long-term corporate bonds returned 6.2 percent. What was the risk premium on small-company stocks for that period?

o 11.3 percent
o 12.4 percent
o 13.6 percent
o 14.4 percent

Answer 1

The risk premium on small-company stocks compared to the average return on U.S. Treasury bills for the given period is 13.6 percent, signifying the additional return an investor would expect for taking on the risk of investing in these stocks over the risk-free alternative.

Step-by-step explanation:

The risk premium on small-company stocks for the provided period can be calculated by subtracting the average return on U.S. Treasury bills (considered a risk-free investment) from the average return on small-company stocks. Using the given data, the risk premium is computed as follows:

Average return on small-company stocks: 17.4%
Average return on U.S. Treasury bills: 3.8%

Risk premium = 17.4% - 3.8% = 13.6%

The direct answer in 2 lines is that the risk premium on small-company stocks for that period is 13.6 percent. This calculation assumes that the average return on U.S. Treasury bills is the risk-free rate, which is a common benchmark for calculating risk premiums in financial analysis.