Historical average return of the S&P 500 or similar index.
1.0 = Market Volatility. >1.0 = Higher Risk.
Please enter valid numeric values for all fields.
Market Risk Premium (Rm – Rf):0.00%
Asset Risk Premium (RP):0.00%
Total Expected Return (Re):0.00%
function calculateRiskPremium() {
// 1. Get DOM elements
var riskFreeInput = document.getElementById('riskFreeRate');
var marketReturnInput = document.getElementById('marketReturn');
var betaInput = document.getElementById('betaValue');
var marketPremiumDisplay = document.getElementById('marketPremiumResult');
var assetPremiumDisplay = document.getElementById('assetPremiumResult');
var totalReturnDisplay = document.getElementById('totalReturnResult');
var resultsContainer = document.getElementById('rpResults');
var errorDiv = document.getElementById('rpError');
// 2. Parse values
var rf = parseFloat(riskFreeInput.value);
var rm = parseFloat(marketReturnInput.value);
var beta = parseFloat(betaInput.value);
// 3. Validate Inputs
if (isNaN(rf) || isNaN(rm) || isNaN(beta)) {
errorDiv.style.display = 'block';
resultsContainer.style.display = 'none';
return;
}
// Hide error if valid
errorDiv.style.display = 'none';
// 4. Calculation Logic based on CAPM (Capital Asset Pricing Model)
// Market Risk Premium = Expected Market Return – Risk Free Rate
var marketRiskPremium = rm – rf;
// Asset Risk Premium = Beta * (Market Risk Premium)
var assetRiskPremium = beta * marketRiskPremium;
// Total Expected Return (Cost of Equity) = Risk Free Rate + Asset Risk Premium
var totalExpectedReturn = rf + assetRiskPremium;
// 5. Display Results
marketPremiumDisplay.innerHTML = marketRiskPremium.toFixed(2) + '%';
assetPremiumDisplay.innerHTML = assetRiskPremium.toFixed(2) + '%';
totalReturnDisplay.innerHTML = totalExpectedReturn.toFixed(2) + '%';
// Show results container
resultsContainer.style.display = 'block';
}
How to Calculate Risk Premium Rate
Understanding how to calculate the Risk Premium Rate is fundamental for investors and financial analysts. The risk premium represents the extra return an investor expects to earn for shifting their money from a risk-free investment (like government bonds) to a riskier asset (like stocks or corporate bonds). It effectively quantifies the "price of risk."
This calculator utilizes the Capital Asset Pricing Model (CAPM), the standard financial model used to determine the appropriate required rate of return of an asset based on its relationship to the market.
The Risk Premium Formula
While the general concept of a risk premium is simply the difference between the asset return and the risk-free rate, the calculation for a specific asset usually involves three key variables:
Risk-Free Rate ($R_f$): The theoretical return of an investment with zero risk. In practice, the yield on 10-year U.S. Treasury bonds is often used as the proxy.
Expected Market Return ($R_m$): The average return of the broader market (e.g., S&P 500).
Beta ($\beta$): A measure of a stock's volatility in relation to the overall market.
The calculation is performed in two steps:
1. Market Risk Premium
First, we determine how much the market outperforms the safe rate:
Market Risk Premium = $R_m – R_f$
2. Asset Risk Premium
Next, we adjust this market premium by the specific asset's volatility (Beta):
Asset Risk Premium = $\beta \times (R_m – R_f)$
What do the Input Values Mean?
Risk-Free Rate: If current government bonds are paying 4%, enter 4. This is your baseline.
Market Return: Historically, the stock market averages about 7% to 10% annually. This is the benchmark for a diversified portfolio.
Beta:
$\beta = 1$: The asset moves exactly with the market.
$\beta > 1$: The asset is more volatile (riskier) than the market (e.g., Tech stocks). The risk premium will be higher.
$\beta < 1$: The asset is less volatile than the market (e.g., Utilities). The risk premium will be lower.
Why is Risk Premium Important?
Calculating the risk premium helps investors determine if the potential reward justifies the risk. If a stock has a high Beta but offers a low expected return (Total Expected Return), it suggests the asset is overvalued or not compensating the investor enough for the risk taken.
For corporate finance, this rate is often used as the Cost of Equity, helping companies decide whether a new project will generate returns higher than the cost of the capital required to fund it.