Question

A.4. Suppose a risky security pays an expected cash flow of $83 in one year. The risk-free rate is 3.5%, and the expected return on the market index is 10.5%
a. If the returns of this security are high when the economy is strong and low when the economy is weak, but the returns vary by only half as much as the market index, what risk premium is appropriate for this security?

Answer 1

	Market risk vary maximum half hence beta is equal to 0.50
	Market risk premium = Beta* (Market return - risk free return)
		=0.5*(0.105-0.035)
		=3.5%