Average Returns and Risk Premium Homework Help, Tutoring
The Risk Return Trade-off, Equity Markets, Risk Premium and CAPM Assignment Help, Tutor Help
Average Returns and Risk Premium
Risk Premium:
Risk Premium is the excess money or return that an investor gets over and above the risk free rate of return. Risk premium is the incentive that induces the investor to hold on to that particular investment inspite of the risk associated with it.
Mathematically:
Ra -Rf = Rp, where Ra is the expected return on the asset or the investment, and Rf is the risk free rate of return.
An investor, who earns around 4 percent from Treasury bills itself, would not want to invest in another asset that gives him similar returns. He would want to invest in an asset that would give him a potential return of atleast 5 percent, whereby the risk premium would be 1 percent.
Average Returns:
The returns generated by an asset over a period of time are called average returns. The returns on assets over a period of time, for example, ten years, is collected, summed and is divided by the number of years it has been collected for. It is a simple average of all the returns given by the asset.
The Risk Return Trade-off:
As a logical rule, a high risk investment has high returns and a low risk investment gives low returns. Here, returns refer to the interest rate on that particular investment.
Risk Premium is the excess money or return that an investor gets over and above the risk free rate of return. Risk premium is the incentive that induces the investor to hold on to that particular investment inspite of the risk associated with it.
Mathematically:
Ra -Rf = Rp, where Ra is the expected return on the asset or the investment, and Rf is the risk free rate of return.
An investor, who earns around 4 percent from Treasury bills itself, would not want to invest in another asset that gives him similar returns. He would want to invest in an asset that would give him a potential return of atleast 5 percent, whereby the risk premium would be 1 percent.
Average Returns:
The returns generated by an asset over a period of time are called average returns. The returns on assets over a period of time, for example, ten years, is collected, summed and is divided by the number of years it has been collected for. It is a simple average of all the returns given by the asset.
The Risk Return Trade-off:
As a logical rule, a high risk investment has high returns and a low risk investment gives low returns. Here, returns refer to the interest rate on that particular investment.
Therefore, the risk-return curve is always upward sloping signifying this trade- off.
Generally there are two kinds of risk premiums spoken about in finance: the risk premium in the equity markets, and the risk premium in bonds
Equity Markets:
The risk premium in equity markets is the return earned provided by a particular firm's scrip, some stock or the stock market as a whole over and above the risk free rate of return. Higher returns will mean higher risk premium, as and when compared to lower returns vis a vis the risk free rate of return.
Risk Premium in Bonds:
In this context, credit spread might be a more appropriate term, as this "premium" is the difference between the return from corporate bonds and the risk free rate of return.
Risk Premium and CAPM:
The concept of risk premium is utilized in CAPM or the Capital Asset Pricing Model. The CAPM is a model used to determine the theoretical return on an asset when it is to be constituted in a portfolio that is reasonably diversified and the investment's or security's market risk or systematic risk is known.
The mathematical formula is:
Ra = Rf + βj (Rm - Rf)
Where, (Rm - Rf) represents the risk premium on the asset, and βj represents the systematic risk on the security. Ra is the expected return on the asset.
Numerical Example:
Find out the risk premium of an asset whose expected return is 26%, systematic risk is 14 and the prevailing risk free rate is 3 %.
Here, the given variables are:
Ra = 26%
Bj = 14
Rf = 3%
Rm= x
Now introducing the CAPM formula:
Ra = Rf + βj (Rm- Rf)
26 = 3 + 14 (x- 3)
Solving for x, we get x = 4.64 %,
Therefore, risk premium is Rm - Rf = 4.64 - 3 = 1.64 %
Generally there are two kinds of risk premiums spoken about in finance: the risk premium in the equity markets, and the risk premium in bonds
Equity Markets:
The risk premium in equity markets is the return earned provided by a particular firm's scrip, some stock or the stock market as a whole over and above the risk free rate of return. Higher returns will mean higher risk premium, as and when compared to lower returns vis a vis the risk free rate of return.
Risk Premium in Bonds:
In this context, credit spread might be a more appropriate term, as this "premium" is the difference between the return from corporate bonds and the risk free rate of return.
Risk Premium and CAPM:
The concept of risk premium is utilized in CAPM or the Capital Asset Pricing Model. The CAPM is a model used to determine the theoretical return on an asset when it is to be constituted in a portfolio that is reasonably diversified and the investment's or security's market risk or systematic risk is known.
The mathematical formula is:
Ra = Rf + βj (Rm - Rf)
Where, (Rm - Rf) represents the risk premium on the asset, and βj represents the systematic risk on the security. Ra is the expected return on the asset.
Numerical Example:
Find out the risk premium of an asset whose expected return is 26%, systematic risk is 14 and the prevailing risk free rate is 3 %.
Here, the given variables are:
Ra = 26%
Bj = 14
Rf = 3%
Rm= x
Now introducing the CAPM formula:
Ra = Rf + βj (Rm- Rf)
26 = 3 + 14 (x- 3)
Solving for x, we get x = 4.64 %,
Therefore, risk premium is Rm - Rf = 4.64 - 3 = 1.64 %
Online Live Tutor Average Returns and Risk Premium:
We have the best tutors in Finance in the industry. Our tutors can break down a complex
Average Returns and Risk Premium problem into its sub parts and explain to you in detail
how each step is performed. This approach of breaking down a problem has been appreciated
by majority of our students for learning Average Returns and Risk Premium concepts. You
will get one-to-one personalized attention through our online tutoring which will make
learning fun and easy. Our tutors are highly qualified and hold advanced degrees. Please
do send us a request for Average Returns and Risk Premium tutoring and experience the
quality yourself.
Online The Risk Return Trade-off, Equity Markets, Risk Premium Help:
If you are stuck with The Risk Return Trade-off, Equity Markets, Risk Premium Homework
problem and need help, we have excellent tutors who can provide you with Homework Help.
Our tutors who provide The Risk Return Trade-off, Equity Markets, Risk Premium help are
highly qualified. Our tutors have many years of industry experience and have had years of
experience providing The Risk Return Trade-off, Equity Markets, Risk Premium Homework Help.
Please do send us the Risk Return Trade-off, Equity Markets, Risk Premium problems on which
you need help and we will forward then to our tutors for review.
Other Topics under Investment Analysis
