Question

If the average annual rate of return for common stocks is 11.7 percent, and 4.0 percent for U.S. Treasury bills, what is the average market risk premium?

Answer 1

Answer:

7.7%

Explanation:

Risk premium is the return an investor would want for holding a risky bond. It is the excess return earned over holding a risk free bond

Risk premium = return on risky asset - return on U.S. Treasury bills

The U.S. Treasury bills is considered to be risk free because the US government cannot default

On the other hands, stocks are risky because companies can default on payment of dividends due to various reasons e.g. insolvency

11.7 - 4 = 7.7%