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market risk premium

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Definition of market risk premium

Market Risk Premium Image 1

market risk premium

risk premium of market portfolio. Difference between market return and return on risk-free Treasury bills.



Related Terms:

capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.


control premium

the additional value inherent in the control interest as contrasted to a minority interest, which reflects its power of control


DLOM (discount for lack of marketability)

an amount or percentage deducted from an equity interest to reflect lack of marketability.


QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate


Auction markets

markets in which the prevailing price is determined through the free interaction of
prospective buyers and sellers, as on the floor of the stock exchange.


Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.


Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.


Market Risk Premium Image 2

Bear market

Any market in which prices are in a declining trend.


Black market

An illegal market.


Brokered market

A market where an intermediary offers search services to buyers and sellers.


Bull market

Any market in which prices are in an upward trend.


Bulldog market

The foreign market in the United Kingdom.


Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.


Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.


Capital market

The market for trading long-term debt instruments (those that mature in more than one year).


Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.


Market Risk Premium Image 3

Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.


Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.


Cash markets

Also called spot markets, these are markets that involve the immediate delivery of a security
or instrument.
Related: derivative markets.


Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.


Common market

An agreement between two or more countries that permits the free movement of capital
and labor as well as goods and services.


Common stock market

The market for trading equities, not including preferred stock.


Company-specific risk

Related: Unsystematic risk


Complete capital market

A market in which there is a distinct marketable security for each and every
possible outcome.


Completion risk

The risk that a project will not be brought into operation successfully.


Conversion premium

The percentage by which the conversion price in a convertible security exceeds the
prevailing common stock price at the time the convertible security is issued.


Corner A Market

To purchase enough of the available supply of a commodity or stock in order to
manipulate its price.


Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.


Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.


Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.


Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk


Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.


Currency risk

Related: Exchange rate risk


Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.


Dealer market

A market where traders specializing in particular commodities buy and sell assets for their
own accounts.


Debt market

The market for trading debt instruments.


Default premium

A differential in promised yield that compensates the investor for the risk inherent in
purchasing a corporate bond that entails some risk of default.


Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.


Derivative markets

markets for derivative instruments.


Direct search market

Buyers and sellers seek each other directly and transact directly.


Diversifiable risk

Related: unsystematic risk.


Domestic market

Part of a nation's internal market representing the mechanisms for issuing and trading
securities of entities domiciled within that nation. Compare external market and foreign market.


Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.


Efficient capital market

A market in which new information is very quickly reflected accurately in share
prices.


Efficient Market Hypothesis

In general the hypothesis states that all relevant information is fully and
immediately reflected in a security's market price thereby assuming that an investor will obtain an equilibrium
rate of return. In other words, an investor should not expect to earn an abnormal return (above the market
return) through either technical analysis or fundamental analysis. Three forms of efficient market hypothesis
exist: weak form (stock prices reflect all information of past prices), semi-strong form (stock prices reflect all
publicly available information) and strong form (stock prices reflect all relevant information including insider
information).


Either-way market

In the interbank Eurodollar deposit market, an either-way market is one in which the bid
and offered rates are identical.


Emerging markets

The financial markets of developing economies.


Equilibrium market price of risk

The slope of the capital market line (CML). Since the CML represents the
return offered to compensate for a perceived level of risk, each point on the line is a balanced market
condition, or equilibrium. The slope of the line determines the additional return needed to compensate for a
unit change in risk.


Equity market

Related:Stock market


Eurocurrency market

The money market for borrowing and lending currencies that are held in the form of
deposits in banks located outside the countries of the currencies issued as legal tender.


Event risk

The risk that the ability of an issuer to make interest and principal payments will change because
of rare, discontinuous, and very large, unanticipated changes in the market environment such as (1) a natural
or industrial accident or some regulatory change or (2) a takeover or corporate restructuring.


Excess return on the market portfolio

The difference between the return on the market portfolio and the
riskless rate.


Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.


Exchange risk

The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.


External market

Also referred to as the international market, the offshore market, or, more popularly, the
Euromarket, the mechanism for trading securities that (1) at issuance are offered simultaneously to investors
in a number of countries and (2) are issued outside the jurisdiction of any single country. Related: internal
market


Fair market price

Amount at which an asset would change hands between two parties, both having
knowledge of the relevant facts. Also referred to as market price.


Fallout risk

A type of mortgage pipeline risk that is generally created when the terms of the loan to be
originated are set at the same time as the sale terms are set. The risk is that either of the two parties, borrower
or investor, fails to close and the loan "falls out" of the pipeline.


Federal funds market

The market where banks can borrow or lend reserves, allowing banks temporarily
short of their required reserves to borrow reserves from banks that have excess reserves.


Financial market

An organized institutional structure or mechanism for creating and exchanging financial assets.


Financial risk

The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.


Firm-specific risk

See:diversifiable risk or unsystematic risk.


Fixed-income market

The market for trading bonds and preferred stock.


Flat price risk

Taking a position either long or short that does not involve spreading.


Force majeure risk

The risk that there will be an interruption of operations for a prolonged period after a
project finance project has been completed due to fire, flood, storm, or some other factor beyond the control
of the project's sponsors.


Foreign banking market

That portion of domestic bank loans supplied to foreigners for use abroad.


Foreign bond market

That portion of the domestic bond market that represents issues floated by foreign
companies to governments.


Foreign equity market

That portion of the domestic equity market that represents issues floated by foreign companies.


Foreign exchange risk

The risk that a long or short position in a foreign currency might have to be closed out
at a loss due to an adverse movement in the currency rates.


Foreign market

Part of a nation's internal market, representing the mechanisms for issuing and trading
securities of entities domiciled outside that nation. Compare external market and domestic market.


Foreign market beta

A measure of foreign market risk that is derived from the capital asset pricing model.


Forward market

A market in which participants agree to trade some commodity, security, or foreign
exchange at a fixed price for future delivery.


Forward premium

A currency trades at a forward premium when its forward price is higher than its spot price.


Fourth market

Direct trading in exchange-listed securities between investors without the use of a broker.


Funding risk

Related: interest rate risk


Futures market

A market in which contracts for future delivery of a commodity or a security are bought or sold.


Geographic risk

risk that arises when an issuer has policies concentrated within certain geographic areas,
such as the risk of damage from a hurricane or an earthquake.


Gray market

Purchases and sales of eurobonds that occur before the issue price is finally set.


Herstatt risk

The risk of loss in foreign exchange trading that one party will deliver foreign exchange but the counterparty financial institution will fail to deliver its end of the contract. It is also referred to as settlement risk.


Idiosyncratic Risk

Unsystematic risk or risk that is uncorrelated to the overall market risk. In other words,
the risk that is firm specific and can be diversified through holding a portfolio of stocks.


Index and Option Market (IOM)

A division of the CME established in 1982 for trading stock index
products and options. Related: Chicago Mercantile Exchange (CME).


Inflation risk

Also called purchasing-power risk, the risk that changes in the real return the investor will
realize after adjusting for inflation will be negative.


Insolvency risk

The risk that a firm will be unable to satisfy its debts. Also known as bankruptcy risk.


Interest rate risk

The risk that a security's value changes due to a change in interest rates. For example, a
bond's price drops as interest rates rise. For a depository institution, also called funding risk, the risk that
spread income will suffer because of a change in interest rates.


Intermarket sector

spread The spread between the interest rate offered in two sectors of the bond market for
issues of the same maturity.


Intermarket spread swaps

An exchange of one bond for another based on the manager's projection of a
realignment of spreads between sectors of the bond market.


Internal market

The mechanisms for issuing and trading securities within a nation, including its domestic
market and foreign market.
Compare: external market.


Internally efficient market

Operationally efficient market.


International market

Related: See external market.


International Monetary Market (IMM)

A division of the CME established in 1972 for trading financial
futures. Related: Chicago Mercantile Exchange (CME).


Intramarket sector spread

The spread between two issues of the same maturity within a market sector. For
instance, the difference in interest rates offered for five-year industrial corporate bonds and five-year utility
corporate bonds.


Inverted market

A futures market in which the nearer months are selling at price premiums to the more
distant months. Related: premium.


Liquidity premium

Forward rate minus expected future short-term interest rate.


Liquidity risk

The risk that arises from the difficulty of selling an asset. It can be thought of as the difference
between the "true value" of the asset and the likely price, less commissions.


Locked market

A market is locked if the bid = ask price. This can occur, for example, if the market is
brokered and brokerage is paid by one side only, the initiator of the transaction.


Make a market

A dealer is said to make a market when he quotes bid and offered prices at which he stands
ready to buy and sell.


Mark-to-market

The process whereby the book value or collateral value of a security is adjusted to reflect
current market value.


Marked-to-market

An arrangement whereby the profits or losses on a futures contract are settled each day.


Market capitalization

The total dollar value of all outstanding shares. Computed as shares times current
market price. It is a measure of corporate size.


Market capitalization rate

Expected return on a security. The market-consensus estimate of the appropriate
discount rate for a firm's cash flows.


 

 

 

 

 

 

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