This seems like a basic question, but I’ve seen the following in a few questions and can’t help wonder if the book, or I, am making a mistake.
CAPM says that keq = Rrf + beta(Rmp-Rrf)
I have seen a few questions where the risk free rate is not subtracted in the second term, such that the book’s answer is CAPM = Rrf + beta*Rmp
Am I missing something here? E.g. is there a scenario where beta*Rmp should be used in place of beta(Rmp-Rrf)?
Thank you.
Maybe you are seeing the term Equity Risk Premium (which would be another way of saying market return minus risk free rate)?
I would second what tctreasury mentioned, in that you have to distinguish between “expected return of the market” and “Market/equity risk premium”
The CAPM equation is keq = Rrf + beta (Er(M) - Rrf)
or keq = Rrf + beta(Rmp)
So basically Market Risk Premium (Rmp) is the Expected market Return (Er(M)) minus the Risk Free rate (Rrf).
The expression Rmp-Rrf is also known as Market Risk Premium. In some questions we are given the Market Risk Premium instead of Rmp. So the CAPM is written as Rrf+beta(Market Risk Premium).
Market risk premium, not _ equity risk premium _.
The term equity risk premium is generally applied to a single stock (e.g., the difference between the return on a company’s stock and its bonds), not to the market as a whole.
I’ve always seen MRP and ERP being used interchangebly.
I appreciate what you are saying…I am just quoting verbatim from Schweser (happen to be looking at my 2010 Level 2 books at the time). It also uses ERP in the CFA book.