Why do some investments pay more than others?
Risk premium
Why do some investments pay more than others?
Imagine you're choosing between two savings accounts. One offers a guaranteed 2% interest, while the other promises a higher rate but with more risk involved.
The extra money you might earn from the riskier option compensates you for taking on more uncertainty. This extra is called the risk premium.
Example
The guaranteed 2% is like a safe bet, while the higher rate is like betting on a coin flip, with the extra rate being the reward for the gamble.
Remember this
The risk premium is the reward for accepting higher risk in hopes of a higher return.
Text adapted from Wikipedia, licensed under CC BY-SA 4.0.
Related concepts
the Capital Asset Pricing Model (CAPM) says
Ever wondered why some investments seem riskier than others?
Fama–French three-factor model
Fama-French model adds size and value factors to CAPM
Arbitrage pricing theory
APT uses multiple systematic risk factors; CAPM uses a single market index
Beta (finance)
Beta measures a stock's volatility relative to the market
Risk parity
Risk parity allocates based on risk contribution, not capital allocation
Treynor ratio
Treynor ratio measures excess return per unit of systematic risk
Educational content, not financial advice.
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