Risk Premium

Loading the player...

What is a 'Risk Premium'

A risk premium is the return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is a form of compensation for investors who tolerate the extra risk - compared to that of a risk-free asset - in a given investment.

BREAKING DOWN 'Risk Premium'

Think of a risk premium as a form of hazard pay for your investments. Just as employees who work relatively dangerous jobs receive hazard pay as compensation for the risks they undertake, risky investments must provide an investor with the potential for larger returns to warrant the risks of the investment.

For example, high-quality corporate bonds issued by established corporations earning large profits have very little risk of default. Therefore, such bonds will pay a lower interest rate (or yield) than bonds issued by less-established companies with uncertain profitability and relatively higher default risk.

RELATED TERMS
  1. Market Risk Premium

    The difference between the expected return on a market portfolio ...
  2. Risk-Free Return

    The theoretical rate of return attributed to an investment with ...
  3. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. ...
  4. Risk-Free Asset

    An asset which has a certain future return. Treasuries (especially ...
  5. Risk

    The chance that an investment's actual return will be different ...
  6. Equity Risk Premium

    The excess return that investing in the stock market provides ...
Related Articles
  1. Investing

    Understanding Market Risk Premium

    Market risk premium is equal to the expected return on an investment minus the risk-free rate. The risk-free rate is the minimum rate investors could expect to receive on an investment if it ...
  2. Investing Basics

    How to Calculate Risk Premium

    Think of a risk premium as a form of hazard pay for risky investments.
  3. Investing

    Risk-Free Rate of Return

    The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free ...
  4. Professionals

    Security Market Line And Beta Basics

    This approach to risk will help you better understand business and investing decisions.
  5. Fundamental Analysis

    Calculating the Equity Risk Premium

    Equity risk premium is the excess expected return of a stock, or the stock market as a whole, over the risk-free rate.
  6. Options & Futures

    How Risk Free Is The Risk-Free Rate Of Return?

    This rate is rarely questioned - unless the economy falls into disarray.
  7. Professionals

    Capital Market Theory

    CFA Level 1 - Capital Market Theory. Learn the assumptions behind the capital market theory. Shows what happens to a portfolio's return and variance when adding a risk-free asset.
  8. Investing Basics

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  9. Professionals

    Rate of Return Basics

    CFA Level 1 - Rate of Return Basics. Learn the components of the required rate of return. Discusses the various forms of risk-free rates, which serve as the base for return.
  10. Personal Finance

    Risk-Free & 20% Return? More Like 100% Scam

    An investment that promises a risk-free return of 20% is 100% likely to be a scam.
RELATED FAQS
  1. Is the market risk premium the same for stocks and bonds?

    Take a look at historical equity risk premium and credit spreads in the United States, which suggest that equities carry ... Read Answer >>
  2. What is the correlation between equity risk premium and risk?

    Learn about the relationship between the risk-free rate of return and the equity risk premium, and understand how the risk-free ... Read Answer >>
  3. 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 >>
  4. How is the risk-free rate of interest used to calculate other types of interest rates ...

    Learn how the risk-free rate is used to compare the yields on bonds, and understand how T-bills are used as a proxy for the ... Read Answer >>
  5. What is the historical market risk premium?

    Learn what the historical market risk premium is and the different figures that result from an analyst's choice of calculations ... Read Answer >>
  6. How is it possible for a rate to be entirely risk-free?

    Find out whether there really is such a thing as a risk-free rate of return, and learn why taking the idea of risk-free rates ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center