Not all investors are interested in accepting extra risk in order to receive a h
ID: 2656706 • Letter: N
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
3.00%
3.00%
3.00%
Various Risk Rates
Interest Rate Risk
1.00%
1.50%
1.25%
Credit Risk
0.50%
0.25%
0.25%
Inflationary Risk
0.50%
0.50%
0.50%
Liquidity Risk
0.25%
0.25%
0.50%
Market Risk
0.50%
0.50%
0.50%
Business Risk
1.25%
0.50%
1.50%
Security 1
Security 2
Security 3
Risk Premium
Nominal Rate of Interest
Expected Annual Return*
QUESTIONS:
a. Fill in the blank spaces for risk premium, nominal rate of interest and expected annual return.
b. What is the minimum about of interest an investor would require for each of these securities. (25 points)
Security 1
Security 2
Security 3
Risk-free Rate of Interest
3.00%
3.00%
3.00%
Various Risk Rates
Interest Rate Risk
1.00%
1.50%
1.25%
Credit Risk
0.50%
0.25%
0.25%
Inflationary Risk
0.50%
0.50%
0.50%
Liquidity Risk
0.25%
0.25%
0.50%
Market Risk
0.50%
0.50%
0.50%
Business Risk
1.25%
0.50%
1.50%
Security 1
Security 2
Security 3
Risk Premium
Nominal Rate of Interest
Expected Annual Return*
QUESTIONS:
a. Fill in the blank spaces for risk premium, nominal rate of interest and expected annual return.
b. What is the minimum about of interest an investor would require for each of these securities. (25 points)
?Explanation / Answer
sec 1 sec 2 sec 3
risk premium 4% 3.5% 4.5%
nominal rate of int 3.5% 3% 4%
(Real int rate -inflation effect)
expected annual return 3+4=7% 3+3.5=6.5% 3+4.5=7.5%
MInimum amt of int required shall be the risk free rate of sec i.e 3% from each of the securities.
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