Q:

What is the formula for default risk premiums?

A:

Quick Answer

To calculate the default risk premium, the rate of return for a risk-free purchase must be subtracted from the rate of return for a purchase that is considered being made. The rate of return for a risk free purchase means an asset that poses no risks associated with it.

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Full Answer

The default risk premium, or just risk premium, is actually the amount the investor wants to earn by purchasing a particular asset compared to another asset. This formula should be considered before the purchase of any asset, so that the investor will know at a minimum how much he can expect back on his risky investments. This formula, if adjusted slightly, can also provide the maximum amount, the minimum amount and the average risk premium that can be earned during a period of time.

Technically, in things like the stock market, the risk-free rate is measured in terms of the United States dollar bill; however, when speaking just financial theory, the risk-free rate is actually anything without any type of investment at all. Time can be considered money in some situations, so time put in can be considered an investment; however, stocks cannot be purchased with time. Market risk premium is using the same formula, but it is the average return rate of the entire market; default risk premiums generally allude to only one type of stock, business or purchase.

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