Answer
Stocks have a greater incurred risk therefore the stockholders demand a greater compensation from this risk than bond-holders. This is all because the stockholder is betting on the future value of a firm. There is a positive relationship between risk and return. The greater the risk the greater the return and vice versa.
Work Step by Step
This question asks you to think about the valuation of stocks and why they are valued at the price they are. Then it asks you to think about how stocks reflect a higher return which is based on the volatility of the market, Price to Earnings Ratio, and other various factors.
