A risk premium is one way to measure the risk you'd take in buying a specific investment. Some analysts define risk premium as the difference between the current risk-free return - defined as the yield on a 13-week US Treasury bill - and the total return on the investment you're considering.
Other measures of risk premium, which are applied specifically to stocks, are a stock's beta, or the volatility of that stock in relation to the stock market as a whole, and a stock's alpha, which is based on an evaluation of the stock's intrinsic value.
Similarly, the higher interest rates that bond issuers typically offer on bonds below investment grade may be considered a risk premium, since the higher rate, and potentially greater return, is a way to compensate for the greater risk.
- Browse Related Terms: Bond fund, Bond rating, Currency, Duration, Fallen angel, Gold standard, High-yield bond, Investment grade, Junk bond, Moody's Investors Service, Inc., Rating, Rating service, Risk premium