When an investment yields a lower rate of return than a risk-free security, this is known as a negative risk premium.
What is risk premium?
- Risk is a factor in almost all investments to some extent.
- Due to the US Treasury Department's backing of US government securities, which still carry some resale risk, there is no default risk.
- This rate is therefore regarded as a risk-free rate of return on these investments.
- Investors who take on more risk typically expect a risk premium, or return above and beyond the risk-free rate.
- Any investment's risk premium is just the variation in return between the risk-free rate and the investment's return.
- Using historical data or forecasting future risk premiums, analysts can also study historical data using risk premium.
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