If the bond yield plus risk premium = YTM + Risk Premium Is the risk premium that they refer to = beta(Market Return - Risk Free Rate) I think every problem I have seen has just given the risk premium.
No, I believe it’s the risk premium over a comparable US bond. The other “risk premium” is for CAPM…
Equity risk premium always mean whatever premium in additional to the risk free rate. Bond yield plus risk premium is one way to estimate equity risk premium.
eltia Wrote: ------------------------------------------------------- > Equity risk premium always mean whatever premium > in additional to the risk free rate. Bond yield > plus risk premium is one way to estimate equity > risk premium. if equity risk premium = R(M) - rfr then is MARKET risk premium = b[R(M) - rfr] and also, is market risk premium equal to “risk premium”
wat!? CAPM approach: Equity risk premium = Market return - risk free return bond yeild approach: Equity risk premium: YTM on the debt + some 2-4% depending on country Historical approach: observed equity risk premium. this is all confusing anyways.
so then u find the erp via the bond yield apprach and then u can input the erp into the capm equation?
Market risk premium is whatever you subtract RFR from. It is different from equity premium.
eltia Wrote: ------------------------------------------------------- > Market risk premium is whatever you subtract RFR > from. It is different from equity premium. Actually this is not correct. MRP = E® - RFR. ERP is whatever in excess of the RFR. I believe they can be used interchangeably, depending on which context. e.g. in PM it’s called MRP. In Equity, it’s called ERP.
eltia is correct.
Okay folks, ERP=MRP=E(Rm or Re)-Rf, this assumes when you talk of market risk premium you are talking about the equity market (i.e. Rm=Re). @the show: the risk premium for a particular single equity (i.e. given stock), the equity risk premium would be : Beta(stock)*ERP=Beta(stock)*(E(Rm)-Rf), consequently this is also actually the full formula for the market.equity risk premium because the beta for these is just 1 and so it simplifies down the equivalent condition in the first line of my post.
“the equity risk premium would be : Beta(stock)*ERP” Equity Risk Premium = Beta*Equity Risk Premium You sure you want to write that? 
Required return on share i = Current expected risk-free return + Beta_i* (Equity Risk Premium) This is the equation in Equity ______________________________ Required return on asset = RFR + beta*market risk premium This is the equation in PM
As a company’s business risk rises it is immediately reflected in bond yields. This method uses normal spreads of equity returns over corporate bond yields, say around 3-4%. r = RD + Risk Premium
Ok…so was I right at the beginning? Equity Risk Premium = Beta(Market Return - Risk Free Rate) Market Risk Premium = (Market Return - Risk Free Rate)
^ I think this is wrong for Equity risk premium. Market Risk premium is correct. It is the excess of market return to risk free rate, which is what you have. Equity Risk premium = excess return on a stock - risk free rate. I believe it would be: Market return * Beta - Risk Free rate (not in parenthesis).
TheAliMan Wrote: ------------------------------------------------------- > Required return on share i = Current expected > risk-free return + Beta_i* (Equity Risk Premium) > > > This is the equation in Equity > ______________________________ > > Required return on asset = RFR + beta*market risk > premium > > This is the equation in PM Page 101 Equity CFAI
TheAliMan Wrote: ------------------------------------------------------- > TheAliMan Wrote: > -------------------------------------------------- > ----- > > Required return on share i = Current expected > > risk-free return + Beta_i* (Equity Risk > Premium) > > > > > > This is the equation in Equity > > ______________________________ > > > > Required return on asset = RFR + beta*market > risk > > premium > > > > This is the equation in PM > > Page 101 Equity CFAI so does that mean that ERP and MRP are interchangeable? i.e. ERP = MRP = E® - rfr
Well, the reason why I originally posted was because of the following question If the expected return on the equity market is 10%, the risk-free rate is 3%, and an asset’s beta is 0.6, what is the appropriate equity risk premium for the asset in applying the Gordon growth model? A) 4.20%. B) 6.40%. C) 9.00%. Your answer: A was correct! The asset’s equity risk premium is equal to it’s beta times the difference between the expected return on the equity market and the risk-free rate. Equity Risk Premium = 0.6(0.10 - 0.03) = 0.042 or 4.2% But I guess when the refer to the ERP of this specific model, you multiply by beta.
Expected return is the entire CAPM, whereas, ERP is just Beta(Rm-Rfr)
TheAliMan Wrote: ------------------------------------------------------- > “the equity risk premium would be : > Beta(stock)*ERP” > > Equity Risk Premium = Beta*Equity Risk Premium > > You sure you want to write that? Yes I am sure I want to say this because you are leaving a crucial preceding statement, which says: “the risk premium for a particular single equity (i.e. given stock)” which means that Beta(stock)*Equity Risk Premium refers to the equity risk premium of a particular stock, hence the Beta(stock), and since a single stock is an equity this would be the given stocks equity risk premium. However, most times we are dealing with the market, and market risk premium is E(Rm)-Rf, consequently this is identical to the [whole market] equity risk premium which can be written as either E(Rm)-Rf of Beta(mkt)*[E(Rm)-Rf] since Beta(market)=1. Summarizing, we have: Market Risk Premium: E(Rm)-Rf Equity Risk Premium (when the equity we are referring to is a single stock): Beta(equity security)*[E(Rm)-Rf]=Beta(equity security)*MRP=Beta(equity security)*ERP(equity universe) Equity Risk Premium (when the equity we are referring to is the entire equity universe): E(Rm)-Rf=Beta(equity universe)*[E(Rm)-Rf], because Beta(equity universe)=1