The "market RISK premium" a) Is the additional market return over the risk-free rate required to compensate for taking risk O b) Measures a stock's price individual volatility relative to that of an average stock c) Is the cost of issuance of new common stock d) Is the "total return on investment" of a stock
The "market RISK premium" a) Is the additional market return over the risk-free rate required to compensate for taking risk O b) Measures a stock's price individual volatility relative to that of an average stock c) Is the cost of issuance of new common stock d) Is the "total return on investment" of a stock
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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The “market RISK premium”
Transcribed Image Text:**Understanding the "Market RISK Premium"**
The "market RISK premium" is a crucial concept in finance, particularly in the fields of investing and portfolio management. It represents the compensation investors expect for taking on the additional risk associated with investing in the stock market over risk-free securities, such as government bonds.
### Multiple-Choice Question:
What is the "market RISK premium"?
**a) Is the additional market return over the risk-free rate required to compensate for taking risk**
**b) Measures a stock’s price individual volatility relative to that of an average stock**
c) Is the cost of issuance of new common stock
d) Is the “total return on investment” of a stock
### Explanation of the Choices:
- **Option a):** This is the correct definition of the market risk premium. It quantitatively expresses how much more return an investor demands to invest in the market as a whole rather than in risk-free assets.
- **Option b):** This option describes the concept of beta, which measures a stock’s individual volatility compared to the overall market. While related to risk, beta is not the same as the market risk premium.
- **Option c):** This option is related to the cost of equity, which is the return a company needs to offer investors to compensate for the risk of investing in its new common stock. This is not the same as the market risk premium.
- **Option d):** This option defines the "total return on investment" which includes both capital gains and dividends received from a stock. While important, it is not synonymous with the market risk premium.
This question aims to clarify the specific meaning and implication of the market risk premium within the context of financial theory and investment practice. Understanding these distinctions is essential for making informed financial decisions and effectively managing investment risk.
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