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Risk Premium
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.
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.
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.
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.