In some cases, brokerage firms provide an expected market rate of return based on an investor's portfolio composition, risk tolerance and investing style. Depending on the factors accounted for in the calculation, individual estimates of the expected market return rate can vary widely.
For those who do not use a portfolio manager, the annual return rates of the major indexes provide a reasonable estimate of future market performance. For most calculations, the expected market return rate is based on the historic return rate of an index such as the S&P 500, the Dow Jones Industrial Average, or DJIA, or the Nasdaq.
Market Risk Premium
The expected market return is an important concept in risk management, because it is used to determine the market risk premium. The market risk premium, in turn, is part of the capital asset pricing model, (CAPM) formula. This formula is used by investors, brokers and financial managers to estimate the reasonableÂ expected rate of return on a given investment.
The market risk premium represents the percentage of total returns attributable to the volatility of the stock market, and is calculated by taking the difference between the expected market return and the riskfree rate. The riskfree rate is the current rate of return on governmentissued Treasury bills (Tbills). Though no investment is truly riskfree, government bonds and bills are considered almost failproof since they are backed by the U.S. government, which is unlikely to default on financial obligations.
For example, if the S&P 500 generated a 7% return rate last year, this rate can be used as the expected rate of return for any investments made in companies represented in that index. If the current return rate for shortterm Tbills is 5%, the market risk premium is 7%  5%, or 2%. However, the returns on individuals stocks may be considerably higher or lower depending on their volatility relative to the market.

Is market risk premium the same for all investors and investments?
Learn about how market risk premiums are determined, how they are calculated, why some assets require higher premiums and ... Read Answer >> 
What is the formula for calculating the capital asset pricing model (CAPM)?
Learn about the capital asset pricing model, or CAPM, and how this formula is used to determine the expected rate of return ... Read Answer >> 
What is the correlation between equity risk premium and risk?
Learn about the relationship between the riskfree rate of return and the equity risk premium, and understand how the riskfree ... Read Answer >> 
What does a high equity risk premium signify about a company's stock future?
Learn about how a high equity risk premium affects a stock's future. These types of stocks tend to be the most volatile instruments ... Read Answer >> 
How is the riskfree rate of interest used to calculate other types of interest rates ...
Learn how the riskfree rate is used to compare the yields on bonds, and understand how Tbills are used as a proxy for the ... Read Answer >> 
How is it possible for a rate to be entirely riskfree?
Find out whether there really is such a thing as a riskfree rate of return, and learn why taking the idea of riskfree rates ... Read Answer >>

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Market Risk Premium
The difference between the expected return on a market portfolio ... 
Risk Premium
The return in excess of the riskfree rate of return that an ... 
RiskFree Asset
An asset which has a certain future return. Treasuries (especially ... 
Capital Asset Pricing Model  CAPM
A model that describes the relationship between risk and expected ... 
Equity Risk Premium
Equity risk premium refers to the excess return that investing ... 
Abnormal Return
A term used to describe the returns generated by a given security ...