Market Risk Premium: Definition, Formula, and Explanation.

Why Is Market Risk Premium Essential

We all wish to put some of our investments in the shares market. But, we all deep down also know that it is risky to put your money in those markets. So, if you are ready to take the risk then only you should invest your money in the shares market. But, nowadays there is a number of share markets available in the market today. So, people often get confused with which one would be best to go with. So, you start searching for the best and the most trusted share market to invest your money in. As we go on searching we find that there are many phases we have to go through in order to find the best share market. The phases can be named such as accumulation phase, mark-up phase, distribution phase, and mark-down phase. But, the main thing that comes is market risk, these share markets always discuss the market risks and their solutions. So, in this article, we will talk about the same. So, after hearing about market risks many questions start arriving in our mind such as what are market risks, how are they discussed as so on. So, basically, in this article, we will be talking about market risk premium, and I will try to answer each and every question with the help of this article that comes to your mind after hearing about market risk premium. So, let’s start with the article as follows.

What Is The Meaning Of Market Risk Premium?

What Is The Meaning Of Market Risk Premium

The meaning of market risk premium can be defined as the difference between the expected return on a market portfolio and the risk-free rate. In simpler words, you can also explain the meaning of market risk premium as the additional return an investor will receive or expects to receive from holding a risky market portfolio instead of risk-free assets. It is basically the part of CAPM (Capital Asset Pricing Model)which analysts and investors use to calculate the acceptable rate of return for an investment.

What Is The Formula Used To Calculate Market Risk Premium?

The formula used for the calculation of the market risk premium is as follows:-

Market risk premium = Supposed rate of return – Risk-free rate.

Why Is Market Risk Premium Essential?

Determine The Market Risk Premium

The market risk premium is essential in examining the asset allocation and for the assessment of the company. It aids the investor or the company is taking up obligatory decisions related to the investments. Whereas, as it is the essential part of CAPM it characterizes the relationship between the beta factor of risky assets and its expected return. Hence, the market risk premium is of major importance for company valuation and for asset allocation decisions.

What Are The Concepts That Are Used To Determine The Market Risk Premium?

There are mainly three main concepts that are part of the market risk premium and are used to determine the market risk premium. Whereas, those concepts can be named as follows.

Three main concepts used to determine market risk premium:

  • Required market risk premium
  • Historical market risk premium
  • Expected market risk premium

Conclusion:       

I hope that you may have got the basic idea about market risk premium and I also hope that all your doubts related to market risk premium may have been cleared out with the help of this article.

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