Which among the following is unique to a security?
a. Risk free rate
b. Risk premium
c. Rates of expected inflation
d. Nominal interest rates
e. None of the above
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The correct option is option b, risk premium.
The risk free rate is a rate of return that can be obtained without taking on any risk. This is usually the rate of return of interest bearing securities like bonds issued by the government. The interest earned on these is assured as the government can, if required, print extra money to honor its debt. It is common for all securities.
Rates of expected inflation are applicable to and common for all securities. Inflation deflates the returns earned from all securities to the same extent.
The nominal interest rate is usually taken as the rate of interest which an investor can get by buying government risk-free bonds without adjusting the returns for inflation. This is also common for all securities.
The risk premium is the extra returns that are sought by investors for buying securities which do not have a certain rate of return. This could include interest bearing instruments issued by companies where there is a possibility of defaul or stock which can change in price based on numerous factors, some of which are profits made by the company, future growth prospects, liquidity, etc.
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