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Suppose a risky investment, with a required rate of return of 15 percent, offers to pay...

Suppose a risky investment, with a required rate of return of 15 percent, offers to pay $100 three years from today (at t=3). Suppose the riskless rate is 2 percent. What is the implied deduction for risk (i.e., based on the corresponding certainty equivalent cash flow at t=3)?

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Answer #1

Rate of return on risky investment = 15%

Amount which a investor get after 3 years on investing = $ 100

Therefore present value of $100 discounyted at 15% will be

   = 65.75

So if this amount is invested in riskless investment, amount of money a investor will get after 3 years at 2% is

  

Implied deduction for risk = Return on risky investment - return on riskless investment

= 100 - 69.77

= $ 30.22 ------------------------------- (Answer)

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