To solve this problem, we need to understand the components of the security market line (SML) equation:
E_R = R_f + (R_m - R_f) b
where:
- E_R is the expected return of the security.
- R_f is the risk-free rate.
- R_m is the expected market return.
- b is the beta of the security, which measures its volatility compared to the market.
The expression (R_m - R_f) is known as the market risk premium. It represents the additional return expected from the market portfolio compared to the risk-free rate.
The risk premium of the security is the portion of its expected return that compensates for the risk taken by the investor above the risk-free rate. In the equation, this is represented by:
(R_m - R_f) b
This is because (R_m - R_f) b accounts for the security's additional expected return due to its systematic risk (as measured by beta) compared to the market portfolio.
Therefore, the correct answer is the option (R_m - R_f)b, which represents the risk premium of the security.
Let's clarify why the other options are incorrect:
- R_f: This is the risk-free rate, not a risk premium.
- (R_m - R_f): This is the market risk premium, not the security's specific risk premium.
- R_f \times b: This is not a standard term used in the context of risk premiums.
Important Questions from Dividend decision
Declared and paid dividend Rs. 7,00,000 is
Which of the following assumptions form the basis of the MM Hypothesis in stating irrelevance of capital structure regarding the weighted average cost of capital remaining constant?
(A) Perfect capital markets
(B) Heterogenous risk class
(C) Absence of taxes
(D) Full dividend payout
(E) Same expectation of firm's EBIT with which to evaluate the value of a firm
Choose the correct answer from the options given below
The formula \(P_0=\frac{D}{K}+\frac{\frac{R}{K}(E-D)}{K}\) (Where P0 is market price of shares, E is earning per share, D is dividend per share, R is rate of Return and K is cost of equity) for determining the dividend of the firm has been given by: :
Given below are two statements, one labelled as Assertion (A) and the other labelled as Reason (R). Read the statements and choose the correct answer using the code given below.
Assertion (A): As per M-M hypothesis the value of the levered firm is equal to the value of the unlevered firm.
Reason (R): The process of arbitrage becomes applicable in such situations.
- The earning per share for Avanti corporation is Rs. 4.0. The rate of return on investments is 16 per cent and the return required by its shareholders is 12 percent. What will be the price per share as per the Walter model, if the payout ratio is 40 per cent?
