Required Rate of Return on a Security | CFA Level 1 Exam Preparation

Determining the Required Rate of Return on a Security

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Question

The required rate of return on a security is determined by

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A. three factors: the real risk-free rate of return, the expected rate of inflation, and the risk premium. The real risk-free rate of return and the expected rate of inflation are used to arrive at the nominal risk-free rate. The risk premium of a security is a function of its variance, and may well fluctuate over time.

B. two factors: the real risk-free rate of return and the risk premium. The risk-free rate of return may be influenced in the short-term by tightness or ease in the capital markets. The risk premium of a security is a function of its variance, and tends to be stable over time.

C. two factors: the real risk-free rate of return, and the risk premium. The risk-free rate of return should depend on the real growth rate of the economy because capital should grow at least as fast as the economy. The risk premium of a security is a function of its risk relative to the market, and tends to be stable over time.

D. three factors: the real risk-free rate of return, the expected rate of inflation, and the risk premium. The risk-free rate of return (which along with inflation determines the nominal risk-free rate) may be influenced in the short-term by tightness or ease in the capital markets. The risk premium of a security is a function of its risk relative to the market, and may well fluctuate over time.

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A. B. C. D.

Although the long-term risk-free rate of return should depend on the real growth rate of the economy, it may be influenced in the short-term by tightness or ease in the capital markets. The nominal risk-free rate is equal to (1 + real risk-free rate) x (1 + inflation rate) - 1. The risk premium is the extra yield that a security requires over the nominal risk-free rate to be attractive to investors.

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