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Finance Allah shmoop What is risk premium No it's not

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This movie in three D risk premium comes from the

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notion that when you invest in pretty much anything other

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than US government debt there is more risk in that

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other investment like even by the bonds of Disney or

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Coke or GOOG or some other behemoth company of those

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bonds carry more risk than US government paper And if

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you bought the stocks I even equities not the bonds

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of one of those beam off cos Well there's way

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more risk Well historically stocks have swung up and down

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violently in short periods over time but over long periods

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of time they've gone up Ah lot Well regardless where

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there is more perceived risk investors will demand more potential

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reward Yeah the key idea here every investment carries more

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risk than US government paper So on top of whatever

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U S Government bonds air yielding investors tag on top

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of them a premium investment return that they require to

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be interested in investing So if say a five year

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U S Government bond is yielding three percent and you're

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looking at investing in bonds backed by a controversial low

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warlord Somalian company Well there's at least some tangible risk

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of bankruptcy there right Well then those bonds will carry

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meaningful E a higher yield than the US government five

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year paper If the risk that the company doesn't pay

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back its bond is modest well then maybe that premiums

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only one percent on top and those five year bonds

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yield in a four percent If the risk is big

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they might have to yield eight or ten or fourteen

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percent or more But those were extremely high rates at

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least these days The market's telling you that the company

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and backing the money already has one foot in the

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grave So now let's go to a completely different way

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of thinking about this extra risk your local diner Think

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of our risk free five year U S Government bonds

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of yielding three percent and being priced like a dinner

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salad which is the cheapest item on the menu right

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here So everything else will cost more than that salad

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crew tones included So then when you're ordering if you

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wanted a burger it's total gross Cost is seven bucks

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But you could also describe that cost to the angry

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waitress or friendly robot as dinner salad plus four bucks

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The premium tacked onto the salad price is four dollars

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for the burger Well risk is priced and described the

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same way there has to be added investment return to

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reflect the added risk to the investor on any given

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deal Be careful though There's inherent risk even if all

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you do is order to the salad Especially if there's

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been a romaine lettuce E Coli warning recently issued by

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the CDC And you do not want to go there 00:02:32.288 --> [endTime] My God

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