Question

1. What are the differences among the Market return, the Market risk premium, the Market risk price, and the return on an individual asset or a portfolio of assets versus the asset’s or portfolio’s risk premium?

Answer 1

Market Return:

Market return is the historical rate of returns shares and other financial instruments invested in the Security market. It gives a comparison on high risk assets (shares) as well as moderate risk assets and low risk assets (Govt securities) etc.,

Market risk premium:

Market risk premium is the additional return from an underlying risky market portfolio. It is the premium from the market for holding the risky assets than the risk-free asset. Always remember higher the risks, higher the return. it is given by the formula

Market risk premium = Company's Expected rate of Return - Risk free return (Low risk market return)

Market risk Price:

It is the risk that arises from security price volatility or an equity risk or an interest rate risk

The return on an individual asset and the risk of the asset:

Return on a security/asset is determined by its dividend yield or capital gain.So the expected rate of return can be given as the sum of the product of the possible rate of return and their probabilities

E(R) =

Where E(R) = Expected Return, Ri is the expected return with a probability Pi

Risk is the measure of standard deviation for the above average rate of return.

σ =

The return on an portfolio of assets and the risk of the assets:

Return of a portfolio on a set of assets is given by Capital Market Line and the equation is as follows:

Rf - Risk free return

E(Rm) - Return on market portfolio

σm - Standard deviation of the market portfolio

σp - Standard deviation of the portfolio

Risk in case of n portfolio can be given as the follows: