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Market Risk Premium(MRP) - Essay Example

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The paper " Market Risk Premium(MRP) " describes that the market has to offer a tool to evaluate this vis-à-vis the risk involved and this is performed by calculating the Market Premium on the valuation of shares, stocks and debt securities. There are several ways of calculating Market Risk Premium(MRP) but usually, the range is between 5-7%…
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Market Risk Premium(MRP)

It is usual for financial managers and Boards of Directors to be more conservative so that they do not err in costs therefore when they arrive at a hurdle rate, the rate at which investors will start becoming reluctant to invest in their company, and fix a price band that is slightly higher. Through this, they seek to manage costs more prudently to avoid shocks to themselves, but at the same time they cause the investors to shy away from them and lose funding. This is more prevalent in developed markets but in contrast in the emerging markets, due to hidden and accruable values, the investors, both local and overseas are bolder hence the incremental values are higher carrying more MRP.
Despite higher taxes, higher volatility and consequently higher MRP on equity this is preferred over debt as the returns are likely to be better. Another factor for this preference is that unless there is and an event like 9/11 or the Enron crisis, historically the socks have always outperformed the debt or bonds.
Since the market favors equity, it becomes important to calculate MRP on daily, indeed even several times daily, to present both clear and emerging pictures for the investing public to act upon. On the other hand, this also assists the financial managers to plan their fundraising exercises.
MRP is also valuable as it offers insights into past movement and likely future scenario except for events that happen to change it abruptly. At the same time, such subtle changes might also shed light on some expected movements that can affect future calculations.
Those who are against MRP forward the argument that MRP movement causes reactions that might be sharp in some cases as they cause a cascading effect. This can sometimes be detrimental and erode confidence and capital. ... Read More
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