A risk-free investment of $10,000 will return 8%. A risky $10,000 investment has a 50% chance of
Defaulting and returning only $3,000. What default premium must the risky investment offer?
A)10.6%
B)78.0%
C)36.0%
D)25.2%

Question

Quizplus · Accepted Answer

The expected return of the risky investment is:
0.5 * 3,000 + 0.5 * 10,000 * (1 + x) = 0.5 * 10,000 * (1 + 0.08)
1,500 + 5,000 + 5,000x = 5,400
x = 0.78 or 78%
The default premium must be 78% - 8% = 70%.

A Risk-Free Investment of $10,000 Will Return 8