Answers the Question
How much more will a company earn if it accepts a degree of risk?
Calculator for Risk Premium
What Is the Risk Premium?
This formula provides the spread between the rate offered by a given investment and one offered by a risk-free investment.
Why Is it Important?
- Every investment involves some degree of risk. In general, the greater the risk, the higher the return that should be demanded. By understanding the differences in returns, one can decide whether or not a risk is worth accepting.
Formula(s) to Calculate Risk Premium
- RISK PREMIUM = RETURN FROM AN INVESTMENT - RETURN ON A RISK FREE INVESTMENT
- Not considering the maximum and minimum investments. Some investments may require significant sums of money. Others may only allow a small sum to be invested, leading to a situation in which the due diligence isn't worth the effort.
- Not considering time horizons. Some investments may tie up dollars for a long time while risk-free returns go up or down.
- Not measuring or estimating risk correctly.