Certainty Equivalent

What is 'Certainty Equivalent'

Certainty equivalent is a guaranteed return that someone would accept, rather than taking a chance on a higher, but uncertain, return. If you've ever thought about leaving your job to start your own business, and potentially make more money, but decided to stay and continue drawing a salary instead, then the amount of your salary is your certainty equivalent. You might need to come up with a business idea with a higher potential payoff to be convinced to leave the security of your existing job.

BREAKING DOWN 'Certainty Equivalent'

Investments must pay a risk premium to compensate investors for the possibility that they may not get their money back. If an investor has a choice between a U.S. government bond paying 3% interest and a corporate bond paying 8% interest, and he chooses the government bond, the payoff is the certainty equivalent. The company would need to offer this particular investor a potential return of more than 8% on its bonds, to convince him to buy. Thus, a company seeking investors can use the certainty equivalent as a basis for determining how much more it needs to pay, to convince investors to consider the riskier option. The certainty equivalent will vary, because each investor has a unique risk tolerance.

RELATED TERMS
  1. Cash Equivalents

    Investment securities that are short-term, have high credit quality ...
  2. Cash And Cash Equivalents - CCE

    An item on the balance sheet that reports the value of a company's ...
  3. Bond Equivalent Yield - BEY

    A calculation for restating semi-annual, quarterly, or monthly ...
  4. Cost Approach

    A real estate valuation method that surmises that the price someone ...
  5. Fixed-Rate Bond

    A bond that pays the same amount of interest for its entire duration. ...
  6. Yield Equivalence

    The interest rate on a taxable security that would render a return ...
Related Articles
  1. Markets

    What are Cash Equivalents?

    Cash equivalents are money market instruments.
  2. Markets

    Calculating Bond Equivalent Yield

    The bond equivalent yield calculates the semi-annual, quarterly or monthly yield on a discount bond or note.
  3. Trading

    Trade Smarter With Equivalent Positions

    Understanding the concept of equivalent positions will help you trade more efficiently and save money on trade fees.
  4. Retirement

    Equity Vs. Salary: What You Need To Know (FB, GOOG)

    Equity payments are common at startup companies. Equity offers potential for a big payout but is also much riskier than a salary payment.
  5. Personal Finance

    Being too Safe with Your Money Could Turn Risky

    Find out why playing it safe with your retirement savings can actually turn risky, including the basics of inflation risk and interest rate risk.
  6. Retirement

    Should I Invest in Bonds After I Retire?

    Yes, retirees should invest in bonds, but remember that not all bonds are safe investments. Seek the help of a financial advisor.
  7. Markets

    Defining The 3 Types Of Investments

    Investments can be divided into three distinct groups – ownership, lending and cash equivalents.
  8. Managing Wealth

    3 Signs It's Time to Sell Your Bonds

    Learn about three major signals that you should sell your bonds right now, including impending interest rate hikes and bond issuer instability.
  9. Managing Wealth

    Cash Vs. Bonds: What to Pick in Times of Uncertainty

    Learn about the benefits and drawbacks of holding cash versus investing in bonds to ensure you make the right decision about how to best safeguard your money.
  10. Professionals

    Which Is Better: A Salary or Hourly Wages?

    When it comes to getting paid, a salary may be the more prestigious option, but you actually could take home more being paid by the hour. Here's why.
RELATED FAQS
  1. Are mutual funds considered cash equivalents?

    Find out why only money market mutual funds are considered cash equivalents, and learn a breakdown of the different types ... Read Answer >>
  2. What's the difference between short-term investments in marketable securities and ...

    Most of the time, when an investor or analyst searches through the financial statements of a publicly traded company, he ... Read Answer >>
  3. What is the difference between proven and probable reserves in the oil and gas sector?

    Learn how those in the oil and gas sector classify oil reserves and the specific differences between proven and probable ... Read Answer >>
  4. Where do companies keep their cash?

    If you have ever looked over a company's balance sheet, you have no doubt noticed the first account under the current asset ... Read Answer >>
  5. What are the benefits of government bonds?

    Its true for the fact that it is one of the safest instruments to invest, but do you really get the rate of return over a ... Read Answer >>
  6. Does working capital include salaries?

    Learn how unpaid salaries affect the calculation of the working capital, while paid salaries have no effect on the working ... Read Answer >>
Hot Definitions
  1. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  2. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  3. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  4. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  5. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  6. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
Trading Center