Certainty Equivalent Calculator
Certainty Equivalent Calculator helps calculating the Certainty Equivalent.
What is Certainty Equivalent?
Certainty Equivalent is the certainty equivalent is a guaranteed return that someone would accept now, rather than taking a chance on a higher, but uncertain, return in the future.
If an investor has a choice between investing in a government bond paying 2% interest and a corporate bond paying 6% interest, and he chooses the government bond, the payoff differential is the Certainty Equivalent. The corporation would need to offer the investor a potential return of more than 6% on its bonds to convince the investor to buy corporate bond.
The Formula of Certainty Equivalent
The basic formula of the Certainty Equivalent is as follows:
| Certainty Equivalent = |
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Where:
Expected Cash Flow is the cash flow, the risky asset is expected to yield
A risk premium is the return the risky asset is expected to yield, over the risk-free rate of asset (risk-free return)