Ryan Konkol, CFA, is helping Gabriel Miskowiak study for the Level 1 CFA examination. Konkol asks Miskowiak to calculate the market risk premium based on the following assumptions:
Which of the following choices is closest to the correct answer?
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A. B. C. D.B
The Market Risk Premium = Expected Market Return "" Nominal Risk Free Rate. Here, we are given the expected market return, but need to calculate the nominal risk free rate. Then, we can determine the Market Risk Premium.
Step 1: Calculate the Nominal Risk-Free Rate:
Nominal Risk-Free Rate = [(1 + Risk FreeRatereal)*(1 + Inflation Premium)] - 1
= [(1 + 0.04)*(1 + 0.035)] "" 1 = 1.076 "" 1 = 0.076 or 7.6%
Step 1: Calculate the Risk Premium:
Market Risk Premium = Expected Market Return "" Nominal Risk Free Rate
= 12% - 7.6% = 4.4%