ACCA Financial Management (F9) Certification Practice Exam

Which of the following represents the expected returns associated with risky assets?

1. Operating income

2. Equity risk premium

3. Debt financing costs

4. Effective tax rate

The correct answer is: Equity risk premium

The expected returns associated with risky assets are best represented by the equity risk premium. The equity risk premium is the additional return that investors expect to earn from investing in stocks over a risk-free rate, such as returns on government bonds. It compensates investors for taking on the additional risk inherent in equity investments compared to safer options. Risky assets, like equities, come with volatility and uncertainty in returns, and the equity risk premium quantifies the extra compensation for this risk. This concept is foundational in finance, as it helps investors determine the expected return on investments based on the risk involved. Operating income does not reflect the returns on risky assets directly; instead, it indicates the profit a company makes from its operations before interest and taxes. Debt financing costs also do not represent expected returns on risky assets; they refer to the costs borne by a company to service its debt. Lastly, the effective tax rate pertains to the tax obligations of a business and does not relate to the expected returns of investments. Therefore, the equity risk premium is the appropriate choice when considering the returns associated with risky assets.