The risk-free rate is 3.5%. What is the expected risk premium on this security given the following information?
$\begin{array}{lcc}
\text { State of the Economy }&\text { Probability}&\text { E(R) }\
\text { Boom } & .30 &15\% \
\text { Normal } & .55 &8\% \
\text { Recession } & .20 & -11 \%
\end{array}$
A)2.09%
B)3.01%
C)3.20%
D)3.87%
E)4.15%

Question

The risk-free rate is 3.5%. What is the expected risk premium on this security given the following information?
$\begin{array}{lcc}
\text { State of the Economy }&\text { Probability}&\text { E(R) }\
\text { Boom } & .30 &15\% \
\text { Normal } & .55 &8\% \
\text { Recession } & .20 & -11 \%
\end{array}$ 
A)2.09%
B)3.01%
C)3.20%
D)3.87%
E)4.15%

Quizplus · Accepted Answer

The expected return (E(R)) of the security can be calculated using the probabilities and returns for each state of the economy: $E(R) = 0.30*15\% + 0.55*8\% + 0.20*(-11\%) = 4.5\% + 4.4\% - 2.2\% = 6.7\%$. The expected risk premium is the expected return minus the risk-free rate: $6.7\% - 3.5\% = 3.2\%$.

The Risk-Free Rate Is 3 A)209% B)3

The Risk-Free Rate Is 3 A)209%
B)3