In a risk-neutral world, the realized default premium to be expected on a loan
A)will be greater than the expected rate of return.
B)will be equal to zero.
C)will equal the promised return minus the time premium.
D)Both B and C are true.

Question

Quizplus · Accepted Answer

In a risk-neutral world, there is no risk premium needed for the loan, which means that the expected default premium is equal to zero. Therefore, answer B is correct. Answer A and C are incorrect as they imply the presence of a risk premium. In a risk-neutral world, all investors would require the same rate of return on their investments regardless of the risk involved. This means that the expected rate of return would already incorporate any default risk premium, resulting in a realized default premium of zero.

In a Risk-Neutral World, the Realized Default Premium to Be