How Do You Estimate The Market Risk Premium?
There are two sides to most any investment: risk and return. In general, the more risk one is willing to take, the higher the potential for profit (or loss). One way investors measure investment return is by looking at a metric called the market risk premium. Treasury bills represent a security with virtually no risk, andas such they are considered risk free. Any amount over the risk free rate is considered the market risk premium. That is, if the risk free rate (current rate on Treasury bonds) is 4 percent, then any amount over 4 percent is considered the market risk premium. Determine which security to use as a proxy for the risk free rate of return in the market. Most investors believe U.S. Treasury Bonds are risk free as they are backed by the full faith and credit of the U.S. Government. Look up the current yield on the 10-year U.S. Treasury bond (see Resources for a link). Let’s say the current yield on a 10-year U.S. Treasury bond is 5 percent. This is your baseline for comparis
