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Expert-verified Found in: Page 142 ### Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

# a. Suppose you forecast that the standard deviation of the market return will be 20% in the coming year. If the measure of risk aversion in Equation 5.13is A 5 4, what would be a reasonable guess for the expected market risk premium? b. What value of A is consistent with a risk premium of 9%? c. What will happen to the risk premium if investors become more risk tolerant? (LO 5-4)

The correct answer is:

a.8%

b.4.5%

c. Decline in risk premium

See the step by step solution

A = 4

σP = 20%

E (rP) – rF = 9%

## Step 2: Calculation of expected market risk premium

E (rP) – rF = ½A σP2 = ½ x 4 x (0.20)2 = 0.08 = 8.0%

## Step 3: Calculation of value of A

E (rP) – rF = ½A σP2

0.09 = ½ A (0.20)2

A = 0.09/ (1/2 x 0.04) = 4.5

## Step 4: Effect of risk tolerance on risk premium

The increased risk tolerance means decreased risk aversion. This would result in a decline in risk premiums. ### Want to see more solutions like these? 