CFA Practice Question

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CFA Practice Question

From 1926 to 1994, the total annual returns on common stocks averaged 12.2%, small company stocks averaged 17.4%, long-term government bonds averaged 5.2%, and Treasury bills averaged 3.7%. What was the average risk premium earned by long-term government bonds and small company stocks, respectively?

A. 8.5%; 1.5%
B. 0; 12.2%
C. 1.5%; 13.7%
Correct Answer: C

Long-term government bonds = 5.2-3.7=1.5%
Small stocks = 17.4-3.7= 13.7%

User Contributed Comments 9

User Comment
ricksy as treasury bill have 0 risk there is no question of RISK PREMIUM so the return is solely the REAL RISK FREE RETURN and as the company stocks and long term govt. bonds carry some risk this difference between the treasury bills ansd the two is the risk premium
stefdunk actually, NASD specifically states that no investment has 0 risk. Technically, a treasury bill does have risks associated with it, but for the sake of this exam those should be ignored.
mtcfa A t-Bill is the NOMINAL risk free rate, not the real.
SueLiu I don't understand this one: Government bonds bonds should only have inflation premiums associated with it unless they specifically state government bonds held in other currency. The difference between the LT Gov't bond and the T-Bill should be the inflation premium not the risk premium.

I think the answer should be B, 0 risk in LT and 12.2=(Small Company)-(T-bill)-(Inflation premium)
adidas Yes government bonds have embedded inflation premiums (unless they are linked to inflations). The difference between two government bonds will just cancel that out and therefore no inflation premium exists in such a difference.
safash I simply fail to understand this Q
johntan1979 You guys need to go review the CAPM model. Then you'll understand what this question is asking and C is the only correct answer.
jonan203 t-bills = risk free rate
Kevdharr Risk premium is the excess return over a risk-free rate. What investors use as a risk-free rate can vary, but T-bills are used quite often. So the risk premium is simply the return an investment brings in EXCESS of the risk-free rate.
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