Question

You invested in long-term corporate bonds and earned 6.1 percent. During that same time period, large-company...

You invested in long-term corporate bonds and earned 6.1 percent. During that same time period, large-company stocks returned 12.6 percent, long-term government bonds returned 5.7 percent, U.S. Treasury bills returned 4.2 percent, and inflation averaged 3.8 percent.

1. What average risk premium did you earn?

2. Is this good or bad and why?

Please show your work and explain.

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Homework Answers

Answer #1

1. Average Premium earned = Long term corporate bonds - Treasury Bills rate

= 6.1% - 4.2%

= 1.9%

So, The average premium is 1.9%

Note: The treaury bills are issued by the government and considered as risk free security and to calculate the risk premium we does not consider the return on the stocks, while we take long term corporate bonds in consideration.

2. It is not good because the Risk premium is 1.9% while the inflation rate is 3.8%, So the investor would be in loss of he consider the real returns.

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