The market risk premium is defined as __________. the difference between the return on a small firm mutual fund and the return on the Standard and Poor's 500 index the difference between the return on Standard and Poor's 500 index fund and the return on Treasury bills the difference between the return on the risky asset with the lowest returns and the return on Treasury bills the difference between the return on the highest yielding asset and the lowest yielding asset

Investments are divided into classes, ranging from high-risk investments to risk-free investments, and this is based on the concepts of volatility of return (risks) or rates of return (reward). Investors prefer investments with the highest rate of return and the lowest volatility of returns. Treasury bills are among the risk free investments

Market risk premium therefore, is the extra return on investment which an investor receives or hopes to receive on investing in a risky market portfolio, instead of a risk-free asset.

Mathematically, Market risk premium is represented as:

Expected Rate of Return - Risk-free Rate

For example, if an investment has a rate of return of 8% and the current rate of return of a treasury bill is 5%, the market risk premium is: 8% - 5% = 3%