How is the bonus for the risk of failure?
In the world of finance, the risk of risk failure that the investor must pay as a compensation for investment in security that may fail for his / her payment obligations. This is first determined by identifying some kind of risk -free investment and the rate that returns to investors. This rate is deducted from the average return level, for securities of the same type as the studied rate to provide the risk of failure. Investors who also want to include volatility in their calculations could also wish to multiply the risk bonuses of beta, which is security volatility measurement compared to other assets of assets.
The idea of risky bonuses comes into play The best known when bonds are purchased by investors. The investor who buys a bond is generally entitled to regular interest payments and any return on the bond premium. However, this return may not occur if any financial calamity impact the bond issuer that could lead to them togave up their payment obligations. Since this risk exists, investors usually require that the issuer pays the risk of failure as a way of balancing the arrangement.
In determining the premium at the risk of failure, there are two main percentage rates that need to be taken into account. The first is a risk -free return, an average return rate gained from an investment with several risks, such as cashier bonds supported by government money. In addition, the average yield must also be determined, which is the amount of return on investment of a similar type. The takeover of the difference between the two rates provides a risk bonus.
As an example, imagine that a risk -free rate chosen by an investor purchased by a bond is three percent. The average return rate for the type of bonds purchased is 10 percent. In That Case, Premium at risk of failure is 10 percent minus three percent,or seven percent. This means that the investor asks for another seven percent return at the peak of the three percent level without risk to compensate for the risk of failure.
Of course, the volatility of the security can also take into account the risk of failure. For this reason, investors can include beta beta in the calculation. Beta, which is based on one scale, measure how much more or less volatile security is compared with others in the same class. Imagine the continuation of the previous example that the bond that the investor buys has a beta 1.2, which means it is 20 percent more volatile than others in its class, increasing the risk. By multiplying Beta Beta 1.2 previously determined at seven percent, the risk bonus for this bond will jump to 8.4.