Final answer:
The market risk premium is the extra return expected from holding a risky market portfolio instead of risk-free assets, and it is essential in the CAPM for determining an asset's required rate of return. It takes into account the expected rate of return and risks associated with an investment, as well as the actual returns realized at the end of the investment period.
Step-by-step explanation:
The market risk premium can be defined by the difference between the expected market return and the risk-free rate (a), is the reward for bearing nondiversifiable risk (b), is the slope of the security market line (c), and can be expressed as R₍ - R (d). The market risk premium reflects the additional return an investor requires for choosing to invest in the market portfolio over a risk-free asset. It is crucial in financial theory as it is used to calculate the required rate of return on an asset using the Capital Asset Pricing Model (CAPM).
The expected rate of return is a forecasted average return of an investment over an extended period. The term risk indicates the uncertainty associated with the profitability of an investment and includes various types, such as default risk and interest rate risk. Lastly, the actual rate of return is the realized gain or loss at the end of a holding period, including both capital gains and interest or dividends received, making it an important metric for assessing the performance of an investment.