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The risk premium is the additional return that investors require for taking on additional risk. It is the extra return that investors demand for investing in assets that have a higher potential for return but also a higher potential for loss.
The risk premium is based on the principle of risk aversion, which states that investors generally prefer investments with lower risk. As a result, investors are willing to accept higher returns for investments that have a higher risk profile.
The risk premium is measured in terms of the additional return that an asset yields over and above the risk-free rate of return. The risk-free rate of return is the return on a risk-free investment, such as government bonds or Treasury bills.
The risk premium is an important concept in finance that helps investors understand the relationship between risk and return. It is a key factor to consider when making investment decisions.
What is meant by risk premium?
Risk premium is the additional return an investor expects for taking on higher risk, compared to a risk-free investment like government bonds.
What is the risk premium formula?
The risk premium formula is: Risk Premium = Expected Return – Risk-Free Rate It shows the extra return expected over the risk-free rate.
What is risk premium in CAPM?
In the Capital Asset Pricing Model (CAPM), risk premium represents the difference between the expected market return and the risk-free rate, adjusted for the asset’s beta.
How is risk premium calculated in CAPM?
In CAPM, risk premium is calculated as: Risk Premium = Beta × (Market Return – Risk-Free Rate)
What is an example of a risk premium?
If government bonds offer a 3% return (risk-free rate), and stocks offer 8%, the risk premium on stocks is 5%, compensating investors for the higher risk.
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