 This topic has 4 replies, 3 voices, and was last updated Aug2111:44 pm by lucky07.

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Up::3
Ok, I don’t know how this has happened, but with just 1.5 months to go before CFA L2 in May, I’ve only just discovered that there’s a difference between CAPM when you have a market risk premium and equity risk premium.
Is it only the former that holds in equilibrium? So using a market risk premium is only really theoretical measure of systematic risk, and you use required return ERP when valuing a particular stock?
I’ve got a bit confused about this after doing a Schweser mock with a question that only had the market risk premium and not the equity required return

Up::1
The difference between market risk premium vs equity risk premium is a matter of scope:
 Market risk premium represents the additional expected return of the index, market or investment portfolio as a whole, above risk free rate.
 Equity risk premium represents the additional expected return of equity, or single stock, above risk free rate.
Capital Asset Pricing Model (CAPM) is a model for pricing an individual security or portfolio, with the formula:
E(R_{i}) = R_{f} + Î²_{i} (E(R_{m}) – R_{f})
where E(R_{i}) is the expected return on capital asset and E(R_{m}) is the market risk premium.
It would depend on the question, but typically CAPM does not use the equity risk premium of a particular stock in place of market risk premium. The beta (Î²_{i}) is the one that conveys the sensitivity of the expected excess return of the valued asset in relation to the expected excess return of the market.
If you’ve seen a CAPM example that uses ‘equity risk premium’ instead of ‘market risk premium’, maybe they were using this interchangeably to mean ‘equity’ as in ‘equity market as a whole’, since the ‘market’ in market risk is usually an equity market. Or else I’d be interested to see their explanation.
Does that answer your question?

Up::1
So using a market risk premium is only really theoretical measure of systematic risk, and you use required return ERP when valuing a particular stock?
Also slightly confused by the above statement. The CAPM model is a method of determining required return on equity E(R_{i}) using market risk premium E(R_{m})Â and beta of the asset.


Up::0
You are given the following information about corporate stock P and the market: Riskfree rate is 7
The expected return and volatility for corporate stock P is 7 and 33 respectively.
The Expected Return and Volatility for Market is 6 and 12 respectively.
The correlation between the returns of corporate stock P and the market is 18. Assume the Capital Asset Pricing Model holds. Calculate the required return for corporate stock P? Could somebody solve this question?
Thanks.


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