Final answer:
The term 'market risk premium' refers to the additional return expected from investing in the stock market over the risk-free rate. It is a critical concept in investing, considering expected rate of return and associated investment risks. It also helps explain interest rate movements, where an increase in capital supply can lower the interest rates.
Step-by-step explanation:
In financial contexts, the term market risk premium typically refers to the excess return that investors expect to earn from investing in the stock market over a risk-free rate. The correct answer to the student's question is therefore Expected market return minus the Risk-free rate, which is not explicitly listed among the options provided. In essence, the market risk premium is the additional return investors require to be compensated for the risk of investing in stocks, as opposed to putting their money in risk-free securities, such as government bonds.
The Three key components when considering the desirability of an investment are the expected rate of return, risk, and liquidity. Each mechanism for savings - whether bank accounts, bonds, stocks, mutual funds, or tangible assets - should be analyzed based on these factors. Specifically, the expected rate of return is a key ingredient in calculating market risk premium; it represents the average return an investor anticipates over time, while risk, including default and interest rate risk, factors into the actual variability of returns.
When examining interest rate movements in financial markets, a rise in supply (option C) generally leads to a decline in interest rates because more capital is available for borrowing, which tends to push down the price of borrowing money, i.e., the interest rate.