I dont get it decrease, increase, relative, comment, returns

MeteorShower

Look at the Q then see my comment afterward. Thanks

Ben Jacobs, CFA, is attempting to calculate a historical equity risk premium. His first estimate uses geometric mean equity returns and long-term bond yields. His second estimate uses arithmetic mean returns and short-term bond yields. The effect of the changes in methodology in the second estimate, relative to the first, will:
A) both decrease the size of the risk premium.
B) have offsetting effects.
C) both increase the size of the risk premium.

Your answer: B was incorrect. The correct answer was C) both increase the size of the risk premium.

Switching from a geometric mean to an arithmetic mean will increase the mean equity return. All else being equal, that will increase the estimated risk premium. When the yield curve slopes upward, short-term bonds yield less than long-term bonds. Thus, the equity risk premium estimate will be larger when short-term bond rates are used.





*Comment/Question*

"
Switching from a geometric mean to an arithmetic mean will increase the mean equity return."

Fine, I get that, moving on,

When the yield curve slopes upward, short-term bonds yield less than long-term bonds. Thus, the equity risk premium estimate will be larger when short-term bond rates are used.



What ? How? If the curve is upward sloping, Kd is lower on the short end, higher on the long end.


Since Ke=Kd+ b(Rm-Rf), wouldn't the Premium just increase with the Rf *OR* Kd would increase? (maintain the spread) just raising Ke?