Question

The market risk premium is computed by: adding the risk-free rate of return to the inflation rate. adding the risk-free rate of return to the market rate of return. subtracting the risk-free rate of return from the inflation rate. subtracting the risk-free rate of return from the market rate of return. multiplying the risk-free rate of return by the market beta.

Answer 1

Answer:

subtracting the risk-free rate of return from the market rate of return

Explanation:

Market risk premium is the premium over the risk free rate that investors demand for holding a risky asset

Market risk premium = market rate of return - risk free rate

the higher the risk premium, the higher the return investors are demanding and the riskier the investment

for example if risk free rate is 5% , market rate of return in industry A is 10% while in industry B it is 20%

Market premium in A = 10% - 5% = 5%

Market premium in b = 20% - 5% = 15%