Equity risk premium is the return that equity security offers in addition to riskfree rate. Equity risk premium is a component of capital asset pricing model CAPM. The formula gives the concept of systematic risk denoted by equity beta that is multiplied with equity risk premium to assess the real rate of return when added in risk free rate. Equity risk premium is the difference between market return on a security and the risk free rate. This is the return that is incremental to risk free rate.
Assume that IBM is offering a rate of return equaling 7% in the market, and the Rf is 2.5%. The equity risk premium will be 4.5% (7%-2.5%).
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