Glossary

Risk Premium

The risk premium is the additional amount paid to cover the additional risk over a more secure asset.

For example, investors typically look for an Internal Rate of Return (IRR) of about 45%. If this money was invested in another asset class, let's say a bank account, the investor may attract 8%. In this case the Risk Premium is 45 - 8 = 37%. So the investor is looking for a risk premium of 37% over keeping the money on deposit in a bank account (the most liquid and lowest risk asset).

This apparently high premium can be justified in several ways:

  • This is very high risk investment since there are no assets to back up the repayment of the money;
  • Investors typically see 1 in 3 companies succeed so expect those who succeed pay towards those that fail.