Consider the following two investment alternatives. First, a risky portfolio that pays 15% rate of return with a probability of 40% or 5% with a probability of 60%. Second, a Treasury bond that pays 6%. The risk premium on the risky investment is ________.
A)1%
B)3%
C)6%
D)9%

Question

Quizplus · Accepted Answer

To calculate the risk premium, we first need to calculate the expected return of the risky portfolio. 
Expected return = (0.4 x 15%) + (0.6 x 5%) = 9%
Then, the risk premium is calculated as the difference between the expected return of the risky portfolio and the return of the Treasury bond. 
Risk premium = 9% - 6% = 3%
Therefore, the best choice is to invest in the risky portfolio since it offers a higher expected return and a reasonable risk premium.

Consider the Following Two Investment Alternatives