Essay About Risk-Free Rate And Market Risk  Premium

While the CAPM plays this role in developed                                                                                          Markets, no model currently does so in emerging markets                                                                                                                                                              Required return on equity (R): R(e) = Rf+ MRP·SR + Awhere Rf denotes the risk-free rate, MRP the (world) market risk  premium, SR the specific risk of an investment opportunity,and A some additional adjustmentThe Lessard Approach1SR = βp·βc   R = Rf + MRP·( βp·βc).The project beta can be estimated as the beta of the relevant industry with respect to the world market, and the country beta as the beta of the relevant country also withrespect to the world market. No further adjustments are implemented in this approach and, therefore, A=0.The Godfrey-Espinosa Approach 2and second, measures risk as 60% of the volatility of the stock market of the country in which the project is based relative to the volatility of the world market (σc/σ W ). More precisely, σc and σW are the standard deviation of returns of country c’s stock market and that of the world market

A = YSc  ,   SR = (0.60)·(σc/σ W ), R = (Rf +YS c) + MRP·{(0.60)·(σc/σ W )Note that in this model the specie c nature of the projects ignored. Put differently, it makes no difference whether accompany is evaluating a project in the oil, airline, or telecom-medications industries; what matters is the country in which the project is basedThe Goldman Sachs Approach 3If the stock market andthe bond market are perfectly correlated (ρSB=1), they bothrefl ect the same sources of risk; in that case YSc will capture all the relevant risk of investing in country c and, therefore, R = Rf +YS c. If, on the other hand, the stock market and the bond market are Uncorrelated (ρSB=0), each reflects different sources of risk; in that case, YSc quantifies the risk reflected by the bond market, σc/σ Wthe additional risk reflected by the stock market and R = (Rf +YS c)+MRP·(σc/σ W ). For all practicalpurposes it is the case that 0incorporates the risk reflected by both the stock market andthe bond market without double counting sources of risk.SR = (1–ρSB)·(σc/σ W ) ,   A = YSc .R = (Rf +YS c) + MRP·{(1–ρSB)·(σc/σ W )} .Ρsb: Correlation between the country’s stock market and bond market returns.