From 1926 to 2005, the total annual returns on large company US ordinary shares averaged 12.4%, small company shares averaged 17.5%, long-term government bonds averaged 5.8% and Treasury
Bills averaged 3.8%.What was the average risk premium earned by long-term government bonds
And small company shares respectively during that period of time?
A)1.8%; 13.3%
B)2.0%; 13.7%
C)4.4%; 11.9%
D)9.5%; 1.8%
E)None of the above.

Question

Quizplus · Accepted Answer

The risk premium is the difference between the average return on an asset and the risk-free rate of return (which is the return on Treasury Bills in this case).

For long-term government bonds: 
Risk premium = Average return on long-term government bonds - Return on Treasury Bills 
Risk premium = 5.8% - 3.8% 
Risk premium = 2.0%

For small company shares: 
Risk premium = Average return on small company shares - Return on Treasury Bills 
Risk premium = 17.5% - 3.8% 
Risk premium = 13.7%

Therefore, the answer is B) 2.0%; 13.7%.

From 1926 to 2005, the Total Annual Returns on Large