Question 1
Multiple Choice
Confidence Level
0%
Assume the following:
The real risk-free rate of return is 2%.
The expected inflation rate is 3%.
The market-determined rate of a security is 9%.
The sum of the default risk premium, liquidity premium, and maturity premium for this security is closest to:
Explanation
A is correct. According to the CFA curriculum, the market-determined interest rate is composed of:
Nominal rate = Real risk-free rate + Inflation premium + Risk premiums
That is:
9% = 2% (real) + 3% (inflation) + X
Solving for X:
X = 9% − 5% = 4%
This 4% accounts for the sum of the default risk, liquidity, and maturity premiums.
B and C are incorrect because they overstate the risk premium by including parts already accounted for by the real and inflation-adjusted return.