cbrisk_2

The market risk premium for the market as a whole is

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: required for the project's market risk Capital budgeting & risk, a reading prepared by Pamela Peterson Drake 11 Now let's explain how to determine the premium for bearing market risk. We do this by first specifying the premium for bearing the average amount of risk for the market as a whole and then, using our measure of market risk, fine tune this to reflect the market risk of the asset. The market risk premium for the market as a whole is the difference between the average expected market return, rm, and the risk-free rate of interest, rf. If you bought an asset whose market risk was the same as that as the market as a whole, you would expect a return of rm - rf to compensate you for market risk. Next, let's adjust this market risk premium for the market risk of the particular project by multiplying it by that project's asset beta, βasset: Compensation for market risk = β asset (rm - rf). β This is the extra return necessary to compensate for the project's market risk. The asset beta fine-tunes the risk premium for the market as a whole to reflect the market risk of the particular project....
View Full Document

Ask a homework question - tutors are online