Risk Premium

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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.

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    Learn about how market risk premiums are determined, how they are calculated, why some assets require higher premiums and ... Read Answer >>
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  5. How accurate is the equity risk premium in evaluating a stock?

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    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 >>
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