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The inputs for each of these variables and the ultimate interpretation of the risk premium value differs depending on the application as explained in the following sections. Regardless of the application, the market premium can be volatile as both comprising variables can be impacted independent of each other by both cyclical and abrupt changes ...
Interest rate risk analysis is almost always based on simulating movements in one or more yield curves using the Heath-Jarrow-Morton framework to ensure that the yield curve movements are both consistent with current market yield curves and such that no riskless arbitrage is possible.
The market risk premium is determined from the slope of the SML. The relationship between β and required return is plotted on the security market line (SML), which shows expected return as a function of β. The intercept is the nominal risk-free rate available for the market, while the slope is the market premium, E(R m)− R f. The security ...
A bond's market value at different times in its life can be calculated. When the yield curve is steep, the bond is predicted to have a large capital gain in the first years before falling in price later. When the yield curve is flat, the capital gain is predicted to be much less, and there is little variability in the bond's total returns over ...
The Capital Market Line says that the return from a portfolio is the risk-free rate plus risk premium. Risk premium is the product of the market price of risk and the quantity of risk, and the risk is the standard deviation of the portfolio. The CML equation is : R P = I RF + (R M – I RF)σ P /σ M. where, R P = expected return of portfolio
The risk-free rate is commonly approximated by the return paid upon 30-day or their equivalent, but in reality that rate has more to do with the monetary policy of that country's central bank than the market supply conditions for credit.
Repricing risk reflects the possibility that assets and liabilities will be repriced at different times or amounts and affect an institution’s earnings, capital, or general financial condition in a negative way. For example, the management may use non-maturity deposits to fund long-term, fixed-rate securities.
surprise shifts in the yield curve. As a practical matter, indices or spot or futures market prices may be used in place of macro-economic factors, which are reported at low frequency (e.g. monthly) and often with significant estimation errors. Market indices are sometimes derived by means of factor analysis. More direct "indices" that might be ...