1. What is Risk Premium?

Risk premium is the excess return that an investment provides over the risk-free rate. It represents the compensation investors require for taking on the additional risk of a particular investment compared to a risk-free asset.

2. How Does the Calculator Work?

The calculator uses the risk premium formula:

Where:

• Return — The total return percentage of the investment
• Risk-Free Rate — The return percentage of a risk-free asset (typically government bonds)

Explanation: The formula calculates the additional return investors earn for taking on investment risk beyond what they would receive from a risk-free investment.

3. Importance of Risk Premium Calculation

Details: Calculating risk premium is essential for investment analysis, portfolio management, and determining whether an investment's potential return adequately compensates for its risk level.

4. Using the Calculator

Tips: Enter the investment return percentage and the risk-free rate percentage. Both values should be expressed as percentages (e.g., enter 5 for 5%).

5. Frequently Asked Questions (FAQ)

Q1: What is considered a risk-free rate?
A: Typically, government bonds (like US Treasury bills) are used as risk-free rates since they're considered to have minimal default risk.

Q2: Can risk premium be negative?
A: Yes, if an investment's return is lower than the risk-free rate, the risk premium becomes negative, indicating poor performance.

Q3: How is risk premium used in investment decisions?
A: Investors compare risk premiums across different investments to identify opportunities that offer better risk-adjusted returns.

Q4: Does higher risk always mean higher premium?
A: Generally yes, but market inefficiencies can sometimes create situations where lower-risk investments offer better risk premiums.

Q5: How often should risk premium be calculated?
A: Risk premium should be monitored regularly as both investment returns and risk-free rates fluctuate over time.