Multiple Choice
Which of the following statements regarding the cost of preferred stock is accurate?
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7. Receivables and Investments
Introduction to Investments in Securities
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The rate of return on which one of the following has a risk premium of 0\%?
A
Municipal bonds
B
Common stocks
C
U.S. Treasury bills
D
Corporate bonds
Verified step by step guidance1
Understand the concept of 'risk premium': A risk premium is the additional return an investor expects to receive for taking on additional risk compared to a risk-free investment.
Identify the risk-free investment: U.S. Treasury bills are considered risk-free because they are backed by the U.S. government, which has a very low likelihood of defaulting.
Compare other options: Municipal bonds, corporate bonds, and common stocks all carry varying levels of risk, such as credit risk, market risk, or default risk, and therefore have a risk premium.
Conclude why U.S. Treasury bills have a risk premium of 0%: Since they are risk-free, investors do not require additional compensation for risk, resulting in a risk premium of 0%.
Apply this understanding to similar problems: When asked about risk premiums, always identify the risk-free investment first and compare it to other options based on their risk levels.
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