Question

Suppose that a 5-year Treasury bond pays an annual rate of return of 2.9%, and a 5-year bond of the fictional company Risky Investment Inc. pays an annual rate of return of 7.3%. The risk premium on the Risky Investment bond is ___ percentage points.

Answer 1

Answer: The risk premium on the risky investment bond is 4.4%

Explanation: Risk premium is the rate of return by which a risky asset must exceed a risk free asset. The aim of this is to induce an individual to hold the risky asset rather than the risk-free asset.

Risk premium (Rm) is calculated by subtracting the risk free rate (Rf) from the risky investment rate (Ri).

That is Rm= Ri - Rf

= 7.6% - 2.9%

=4.4%

Answer 2

The risk premium is 4.4%

Step-by-step explanation:

The risk premium on any given investment is the difference between the risky investment and the risk free investment and in this case we know treasury bonds are risk free and offer a certain return of coupons because they come from governments rather than the fictional ones like the one from risky investment inc so to find the risk premium we say :

Risk Premium = Risky investment rate - Risk free investment Rate

= 7.3% - 2.9%

= 4.4%