FIN-300-Brockman-UKY

Risk Premium

The excess return earned by a risky asset over the return earned by a risk free rate

Market Risk Premium (MRP)

Slope of the Security Market Line (SML), is the Market Return minus the Risk Free Rate

Risk Free Rate

The security market line intercepts the vertical axis (y) at the risk free rate

If slope of Security Market line increase or decrease this indicates what

Investors risk aversion has also increased or decreased

Capital Asset Pricing Model (CAPM)

Shows the relationship between beta and a stocks required rate of return

Market Risk Premium in the SML Equation

This is a measure of investors risk aversion

Before and After Tax cost of debt

Stockholders focus on after tax capital costs. Only costs of debt needs adjustment because interest is tax deductiable.

The Cost of capital is used primary to make decisions that involve raising new capital.

WACC Equals

Wd x Rd (1-T) + Wps x Rps + Wce x Rs/e

The Market Risk Premium equals the

Market rate of return (-) the risk free rate of return.