Risk premium is the minimum incremental yield by which the expected return on a risky asset must exceed the known return on a risk-free asset in order to induce an individual to hold the risky asset rather than the risk-free asset. The risk-free asset is typically thought of as a U.S. Treasury security with a maturity equal to the expected investment period. U.S. Treasuries produce a known return and, especially short-term Treasuries, are considered to have minimal risk.
As an example calculation, If an investor knows she can receive 3.0% on a government bond and a speculative investment is expected to return 8.0%, then the risk premium is 5.0%. The investor must then decide if the 5.0% “excess return” is enough to justify the increased level of risk. See Risk Adjusted Returns.
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Hypothetical example(s) are for illustrative purposes only and are not intended to represent the past or future performance of any specific investment.
Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments are often sold by prospectus that discloses all risks, fees, and expenses. They are not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain and should not be deemed a complete investment program. The value of the investment may fall as well as rise and investors may get back less than they invested.
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