Question

the market has an expected rate of return of 10.1 percent. the current nominal expected yield on u.s. treasury bills is 3.4 percent. the inflation rate is 2.8 percent. what is the market risk premium?

Answer 1

The market risk premium is the difference between the expected rate of return on the market and the risk-free rate of return.

In this case, the expected rate of return on the market is 10.1 percent and the current nominal expected yield on U.S. Treasury bills (which are considered risk-free) is 3.4 percent. However, we need to adjust the risk-free rate for inflation to get the real risk-free rate.

Real risk-free rate = nominal risk-free rate - inflation rate

Real risk-free rate = 3.4% - 2.8%

Real risk-free rate = 0.6%

Therefore, the market risk premium is:

Market risk premium = Expected rate of return on market - Real risk-free rate

Market risk premium = 10.1% - 0.6%

Market risk premium = 9.5%

So, the market risk premium is 9.5%.