Risk Premium

What is risk premium?

The individuals who take on riskier investments are compensated with a greater return. The risk premium is the amount the investor ought to hope to receive for risking the loss of their money for making the investment.

More profound definition

The risk premium is the rate of return on an investment far beyond the risk-free or guaranteed rate of return.
To work out risk premium, investors must initially ascertain the estimated return and the risk-free rate of return. The estimated return, or the expected return, on a stock alludes to the amount of profit or loss that an investor anticipates from a specific investment.
The estimated return is a projection and is certainly not a guaranteed return. Investors can ascertain the estimated return by increasing the likely results by the percent chance of them happening and afterward adding those computations together.
Ascertaining the estimated return is one way for investors to evaluate the risk of an investment.
The risk-free rate is the rate of return on an investment whenever there is no way of financial loss. For instance, the U.S. government backs Treasury bills, which makes them low risk. In any case, in light of the fact that the risk is low, the rate of return is additionally lower than different types of investments.
In the event that the estimated rate of return on the investment is not exactly the risk-free rate, then the outcome is a negative risk premium. In these examples, investors would be better off investing in a Treasury bill on the grounds that the return is both greater and guaranteed.

Risk premium model

The estimated return minus the return on a risk-free investment is equivalent to the risk premium. For instance, on the off chance that the estimated return on an investment is 6 percent and the risk-free rate is 2 percent, then the risk premium is 4 percent. This is the amount that the investor desires to earn for making a risky investment.

Features

• Investors hope to be compensated for the risk they attempt while making an investment. This comes as a risk premium.
• A risk premium is the investment return an asset is expected to yield in excess of the risk-free rate of return.
• The equity risk premium is the premium investors hope to make for facing the somewhat higher risk challenges buying stocks.