The risk-free rate of return can be thought of as consisting of ____ and ____.
A) a real rate of return; a default premium
B) unanticipated inflation; bond default premium
C) a real rate of return; an inflation premium
D) a zero beta component; an expectation premium

Question

Quizplus · Accepted Answer

The risk-free rate of return can be broken down into a real rate of return, which compensates for the time value of money and opportunity cost, and an inflation premium, which compensates for the expected inflation rate. Choice A is incorrect because a default premium refers to the additional return an investor expects to receive for holding a risky asset, while the risk-free rate is assumed to have no default risk. Choice B is incorrect because unanticipated inflation is a risk, but it is not part of the risk-free rate of return. Choice D is incorrect because a zero beta component and an expectation premium are not components of the risk-free rate of return.

The Risk-Free Rate of Return Can Be Thought of as Consisting