What is a risk premium?

A risk premium refers to the extra return that investors require for taking on additional risk compared to a risk-free investment. This concept is fundamental in finance and investing, as it reflects the compensation that investors seek for bearing the uncertainty associated with riskier assets, such as stocks or corporate bonds, versus safer assets like government bonds.

When investors consider different investment options, they assess the potential returns and the associated risks. The higher the risk of an investment, the greater the expected return has to be to entice investors to bear that risk. This demand for additional returns is what constitutes the risk premium.

In comparison, the other options describe different aspects of finance but do not capture the essence of the risk premium:

• Return on risk-free investments relates to the baseline return available without taking on risk, but it doesn't involve the additional compensation for higher risk.

• Guaranteed returns on bonds speak to fixed income securities that have a defined payout, which means they provide stability rather than a premium for risk.

• Interest rates on savings accounts pertain to standard banking products with minimal risk, and do not address the concept of compensating for additional risk exposure.

Thus, the correct understanding of a risk premium is the extra return demanded for accepting higher risk, which highlights the dynamic between