Dear all,
We have two types of risk premium, one for the market and the second is for the investment.
There are as follows:
1- Market risk premium = market rate - risk free rate
2- Company (investment) risk premium = Beta (market rate - risk free rate)
OK?
After then, you can apply the above concept in CAPM formula as next:
RRR = RF + Beta (market rate - risk free rate)
7.4 %= 3% + 1.4 ( MR - 3%)
7.4% = 3% + 1.4 MR - 4.2%
7.4% - 3% + 4.2% = 1.4 MR
8.6 % = 1.4 MR
Then MR = 8.6 / 1.4 = 6.14 %
Remember that we did not finish yet!
we still need to get the Market premium that's = MR - RF rate
= 6.14% - 3%
= 3.14 %
Note:
"RRR" = required rate of return on investment you think in = Expected rate of return...... and it also differs from the prevailing market rate.
I hope this is helping you.
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Ashraf Mohammad CIA
Finance Director/Manager
Kuwait
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Original Message:
Sent: 08-07-2015 04:20 AM
From: Abdul Kariem Gafaar
Subject: CAPM Question
Expected return = RF + B ( Rm-Rf)
market premium is (Rm-Rf)
7.4= 3 + 1.4 market premium
1.4 MP = 4.4
Market premium = 4.4/ 1.4 = 3.14
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Abdul Kariem Gafaar
Finance Manager
Jabriya
Kuwait
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Original Message:
Sent: 08-06-2015 03:31 AM
From: Lakshmy Varma
Subject: CAPM Question
OK. I might be wrong with respect to formula. But even if you substitute RM-RF in my formula, 3.14 would be (Market rate-Risk free rate), right? Actually (Market rate - risk free rate) when multiplied by Beta gives you the risk premium. In short, in any case risk premium is Expected return-risk free rate. Beta is the multiplier we take for every 1% change in the market rate over and above Risk free rate. Hence Risk "premium" shall be Beta*(RM-RF). Could you please correct me if I am wrong in my concept?
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Lakshmy Varma
Accountant
Millennium Offshore Services
Ajman
United Arab Emirates
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Original Message:
Sent: 08-06-2015 03:21 AM
From: Inam Ullah
Subject: CAPM Question
My Dear,
Thanks for your reply,but as per the Hock Book (Page 144)
The CAPM formula is:
R = RF + β(RM − RF)
Where: R = Investors’ required rate of return
RF = Risk-free rate of return
β = Beta coefficient
RM = Market rate of return
then why should we opt for :
Expected return = Risk free rate + Beta * Market rate
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Inam Ullah
Accountant
JC Maclean International FZCO
DUBAI
United Arab Emirates
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Original Message:
Sent: 08-06-2015 01:59 AM
From: Lakshmy Varma
Subject: CAPM Question
As per my understanding Market risk premium is (Expected rate of return - Risk free rate) or in other words (Beta * Market rate). So if my understanding is correct, the correct answer should be (7.4-3) which is equal to 4.4.
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Lakshmy Varma
Accountant
Millennium Offshore Services
Ajman
United Arab Emirates
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Original Message:
Sent: 08-06-2015 01:54 AM
From: Lakshmy Varma
Subject: CAPM Question
Expected return = Risk free rate + Beta * Market rate
7.4 = 3 + 1.4 * Market rate
7.4 - 3 = 1.4MR
MR = (7.4-3)/1.4
MR = 3.14
But I am not sure if Market rate and Market risk premium are same or not.
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Lakshmy Varma
Accountant
Millennium Offshore Services
Ajman
United Arab Emirates
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Original Message:
Sent: 08-06-2015 01:43 AM
From: Inam Ullah
Subject: CAPM Question
Dear All,
Can any one help me that why correct answer is "a" in the following question?
Using the capital asset pricing model (CAPM), determine the expected market risk premium from the following information.
Beta of Investment A 1.4
Risk-free rate 3.0%
Expected return on Investment A 7.4%
a. 3.14%.
b. 6.14%.
c. 7.43%.
d. 8.28%.
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Inam Ullah
Accountant
JC Maclean International FZCO
DUBAI
United Arab Emirates
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