Question

Not all investors are interested in accepting extra risk in order to receive a higher return. Investors can be classified as risk adverse, risk neutral, or risk seeking. To determine the risk associated with an investment, calculations are made to determine the risk-free rate and the risk premium associated with the investment.

                                               

	Security 1	Security 2	Security 3
Risk-free Rate of Interest	5.00%	5.00%	5.00%
Various Risk Rates
Interest Rate Risk	1.20%	1.50%	1.55%
Credit Risk	0.70%	0.45%	0.25%
Inflationary Risk	0.50%	0.50%	0.75%
Liquidity Risk	0.25%	0.25%	0.50%
Market Risk	0.50%	1.50%	1.50%
Business Risk	2.25%	0.50%	1.75%
	Security 1	Security 2	Security 3
Risk Premium
Nominal Rate of Interest
Expected Annual Return*

QUESTION:

Fill in the blank spaces for risk premium, nominal rate of interest and expected annual return.

Answer 1

Answer)

Nominal rate of interest = ( the real rate of interest + an inflation premium )+ a risk premium.

= Risk free return +  a risk premium.

Risk premium includes business risk, financial risk, interest rate risk, liquidity risk, liquidity risk , market risk and tax risk.

The Expected rate of Return is the nominal rate of return that an investor needs in order to make an investment worthwhile.

So, use of the above concept , calculation below,

	Security 1	Security 2	Security 3
Risk-free Rate of Interest	5.00%	5.00%	5.00%
Various Risk Rates
Interest Rate Risk	1.20%	1.50%	1.55%
Credit Risk	0.70%	0.45%	0.25%
Inflationary Risk	0.50%	0.50%	0.75%
Liquidity Risk	0.25%	0.25%	0.50%
Market Risk	0.50%	1.50%	1.50%
Business Risk	2.25%	0.50%	1.75%
	Security 1	Security 2	Security 3
Risk Premium	5.40%	4.70%	6.30%
Nominal Rate of Interest	10.40%	9.70%	11.30%
Expected Annual Return*	10.40%	9.70%	11.30%