Risk Premium
Risk premium is the additional return that an investor expects to receive for taking on additional risk. It is the difference between the expected return on a risky asset and the return on a risk-free asset. Risk premium is a key concept in finance and is used to calculate the cost of capital for a company or project. It is also used to compare the returns of different investments and to determine the optimal portfolio mix.
History of Risk Premium
The concept of risk premium has been around since the early days of finance. It was first introduced by John Burr Williams in his 1938 book, The Theory of Investment Value. Williams argued that the value of an asset is determined by the expected return on the asset, minus the risk-free rate of return. This concept has since been adopted by many financial theorists and is used to calculate the cost of capital for a company or project.
The concept of risk premium has also been used to compare the returns of different investments. By comparing the expected return of a risky asset to the return of a risk-free asset, investors can determine which investments offer the highest potential return. This is known as the risk-return tradeoff, and it is an important concept in finance.
Risk Premium Table
| Asset | Expected Return | Risk-Free Rate | Risk Premium |
|---|---|---|---|
| Stock | 10% | 2% | 8% |
| Bond | 5% | 2% | 3% |
Summary
Risk premium is the additional return that an investor expects to receive for taking on additional risk. It is the difference between the expected return on a risky asset and the return on a risk-free asset. Risk premium is a key concept in finance and is used to calculate the cost of capital for a company or project. It is also used to compare the returns of different investments and to determine the optimal portfolio mix. For more information about risk premium, you can visit websites such as Investopedia, The Balance, and Investing.com.
See Also
- Cost of Capital
- Risk-Return Tradeoff
- Expected Return
- Risk-Free Rate
- Portfolio Mix
- Capital Asset Pricing Model (CAPM)
- Beta
- Sharpe Ratio
- Value at Risk (VaR)
- Standard Deviation
