Having trouble understanding why the the RF rate isn’t subtracted from the Market Risk Premium here?
What is the expected rate of return on a stock that has a beta of 1.4 if the market risk premium is 9% and the risk-free rate is 4%?
I think I may have answered my own quesition by posting this. The Market Risk Premium already includes the Expected Market Return Minus the Risk-Free Rate. So Essentially, they are giving it both ways and it’s somewhat of a “trick” Question.
You need to know how the market risk premiun is calculated.
Market risk premium (MRP) = E[Rm] - Rf
So they could give you MRP or the E[Rm]. Just be careful and read well.
you are right
market risk premium=market risk free return-rff
thats why its called a premium
Yep, you’re correct in your deduction. As mentioned above, the market risk premium already takes into account the risk free rate; it is the premium beyond Rf. Definitely something to be aware of, have seen a number of questions using each of these notations.
Put simply,
The equation should be as follows:
ra = 0.04 + 1.4( 0.09) = 16.60%
ra = rrf + Ba (rm-rrf)
Definetly something to be aware of! Thank you for bringing it up! Just ran into a similar excercise and this explanation helped!
Also confirm that is needed attention what is asked or mentioned in question, a market risk premium (Market Index (or portfolio) return - RFR, thus whole syntax) or just Market index(portfolio) return which is a variable in market risk premium calculation. As I can find, CFA likes play with words so careful question reading is necessary.