Risk premiums are higher for riskier securities, but the risk premium cannot be higher than the required rate of return.

Question

Quizplus · Accepted Answer

This statement is true. The risk premium represents the additional return an investor requires to compensate for the increased risk of a security compared to a risk-free asset. However, the risk premium cannot be higher than the required rate of return, which is the minimum return an investor expects to receive from an investment to compensate for the time value of money and the opportunity cost of investing in other alternatives. If the risk premium exceeds the required rate of return, it implies that the security is overpriced and does not offer an attractive investment opportunity.

Risk Premiums Are Higher for Riskier Securities, but the Risk