The difference between a market risk premium and an 澳洲幸运5官方开奖结果体彩网:equity risk premium comes down to scope. The market risk premium is the additional return that's expected on an index or portfolio of investments above the given risk-free rate. An equity risk premium applies only to stocks and represents the expected return of a stock above the 澳洲幸运5官方开奖结果体彩网:risk-free rate.

Equity risk premiums are usually higher t𒉰han standard market risk premiums. Equities are typically considered riskier than bonds but less risky than commodities and currencies.

Understanding Market and Equity Risk Premiums

Investments come with varying degrees of risk. There's a risk that the stock price could decline after an investor buys a stock, opening up the possibility of a loss when the position is sold. Investors demand 澳洲幸运5官方开奖结果体彩网:compensation for assuming risk as a result. Investments that carry more risk 𝕴should offer additional opportunities to earn a gain. Investors weigh the risk versus reward in any position.

U.S. 澳洲幸运5官方开奖结果体彩网:Treasury bonds are typically considered risk-free returns if the bond is held to maturity, however. Treasuries are backed by the U.S. government so their yields or interest rates are risk-free. Treasuries are typically used as a benchmark as a result when calculating the risk-free rate that investors could earn had they invested in Treasuries rather than the investment they're considering.

The difference between the risk-free rate and the rate on non-Treasury investments is the risk premium. The premium is ref൩erred to as an equity risk premium when the non-Treasury investment is a stock. It's referred to as the market risk premium when the non-Treas🌄ury investment is a portfolio or a market index such as the S&P 500.

Market Risk Premium

The market risk premium is the difference between the forecasted return on a portfolio of investments and the risk-free rate. Treasuries are considered the risk-free rate so the market risk premium for a portfolio is the variance between the returns on the portfolio and the chosen Treasury yꦐ🅷ield.

There are various types of market risk premiums depending on what the investor is trying to determine. A historical analysis might analyze the difference between a portfolio's return over the last two years and the two-year Treasury yield during that period. The process is fairly straightforward when you're comparing 澳洲幸运5官方开奖结果体彩网:historical market risk premiums but ꧙a ♐portfolio's past performance isn't a predictor of future returns.

The result is subject to human inference if an investor is comparing the market risk premium based on the expected return of a portfolio versus the current two-year Treasury yield. The expected or forecasted market risk premium can vary between investors as a result. Each has its biases, risk-tolerance levels, and views on ꧒the market.

A Market Risk Premium Example

Suppose an individual has $10,000 to invest. They could place the money in Treasury bonds for a relatively low rate of return of 2% per year. They have virtually zero chance of losing their principal if they choose the T-bonds. Any return above and beyond the 2% is the market risk premium reಌquired by investors to commit their money to a portfolio or an index.

The Treasury isn't the only institution that wants this investor's money, however. Corporations offer bonds and stocks to raise capital but they can't offer the same kind of safety that comes with T-bonds. Corporations must increase the offered return on their instruments to entice the investor to place their money with them.

Equity Risk Premium

The equity risk premium is a type of 澳洲幸运5官方开奖结果体彩网:unsystematic or specific risk. It refers to the additi☂onal return from investing in a stock that's above the risk-free rate. Equity risk premiums compensate investors for taking on additional r🧜isk that comes with buying and selling stocks, similar to a market risk premium.

Theꦰ extentඣ of the premium can vary as the stock price fluctuates and as changes occur within the underlying company. The premium depends on the level of risk for the stock or group of stocks being considered. High-risk stocks often have higher risk premiums.

Equity returns can fluctuate depending on the overall macroeconomic conditions in the global economy. Stocks such as 澳洲幸运5官方开奖结果体彩网:retailers that benefit from consumers would likely have a higher risk of loss associated with them if U.S. consumer spending is declining. T𒀰he return on ♒a company's stock is also dependent on many internal factors, however, including the company's financial performance, the effectiveness of its management team, and its product and service offerings.

Equity risk premiums exist because investors demand a premium on the returns for their equity investments versus the returns from low-risk investments or risk-free investments like Treasuries. A higher premium is likely necessary to entice them to buy if an investor's money is at a greater risk for a loss.

The Bottom Line

The market risk premium represents the return of an index or portfolio that exceeds a risk-free rate commonly associated with U.S. Treasury bond✃s. An equity risk premium is based on the same risk-free rate but it applies only to stocks. These premiums are typically higher.

Which is right for you comes down to your tolerance for risk. Speak with an advisor before youꩵ invest if you’re unsure.