Home
Back
Risk Premium Formula:
| From: | To: |
Risk Premium is the excess return that an investment provides over the risk-free rate. It represents the compensation investors require for taking on the additional risk of an investment compared to a risk-free asset.
The calculator uses the Risk Premium formula:
Where:
Explanation: The formula calculates the additional return investors expect to receive for taking on investment risk beyond the guaranteed return of a risk-free asset.
Details: Calculating risk premium is essential for investment analysis, portfolio management, and determining appropriate asset allocation. It helps investors assess whether the potential return of an investment adequately compensates for its risk level.
Tips: Enter the expected return percentage and risk-free rate percentage. Both values should be expressed as percentages (e.g., enter 5 for 5%).
Q1: What is considered a risk-free rate?
A: The risk-free rate typically refers to the yield on government securities, such as US Treasury bills or bonds, which are considered free of default risk.
Q2: How does risk premium vary across different investments?
A: Risk premium varies significantly based on the investment's risk characteristics. Higher-risk investments generally command higher risk premiums.
Q3: Can risk premium be negative?
A: Yes, if the expected return is lower than the risk-free rate, the risk premium becomes negative, indicating the investment may not adequately compensate for its risk.
Q4: How is risk premium used in the Capital Asset Pricing Model (CAPM)?
A: In CAPM, risk premium is a key component used to calculate the expected return of an asset based on its systematic risk (beta).
Q5: What factors influence the size of risk premium?
A: Factors include market volatility, economic conditions, investment liquidity, credit risk, and the specific risk characteristics of the investment.