premium

(noun)

the price above par value at which a security is sold

Related Terms

Examples of premium in the following topics:

  • The "Bond Yield Plus Risk Premium" Approach

    • The risk premium on its equity is 4%.
    • The normal historical equity risk premium for all equities has been just over 6%.
    • In general, an equity's risk premium will be between 5% and 7%.
    • Common methods for estimating the equity risk premium include:
    • Describe the process for the bond yield plus risk premium approach

  • Inflation Premium

    • An inflation premium is the part of prevailing interest rates that results from lenders compensating for expected inflation.
    • An inflation premium is the part of prevailing interest rates that results from lenders compensating for expected inflation by pushing nominal interest rates to higher levels.
    • The inflation premium will compensate for the third risk, so investors seek this premium to compensate for the erosion in the value of their capital, due to inflation.
    • Actual interest rates (without factoring in inflation) are viewed by economists and investors as being the nominal (stated) interest rate minus the inflation premium.
    • In the Fisher equation, π is the inflation premium.

  • The Cost of Common Equity

    • -- Expected return for a security equals the risk-free return for the market plus the beta for the security times its risk premium.
    • The CAPM shows that the cost of equity is equal to the risk free rate plus a premium expected for risk.
    • This premium is sensitized to movements in relevant markets using the beta coefficient.
    • Another approach to calculating the cost of common stock is to add a risk premium to the cost of debt.
    • Expected return for a security equals the risk-free return for the market plus the beta for the security times its risk premium.

  • The Term Structure

    • The expectation hypothesis of the term structure of interest rates is the proposition that the long-term rate is determined by the market's expectation for the short-term rate plus a constant risk premium.
    • This is called the term premium or the liquidity premium.
    • This premium compensates investors for the added risk of having their money tied up for a longer period, including the greater price uncertainty.
    • Because of the term premium, long-term bond yields tend to be higher than short-term yields, and the yield curve slopes upward.
    • Long-term yields are also higher not just because of the liquidity premium, but also because of the risk premium added by the risk of default from holding a security over the long-term.

  • Options Contract

    • Option holders must pay a fee, called the option premium.
    • If the spot market price rises, subsequently, the option's premium for a European call option increases while the premium decreases for the put option.
    • If the strike price increases, then the option's premium for a European call option decreases while the premium increases for a put option.
    • However, the company has paid the $10,000 premium.
    • Speculators would earn a loss, equaling the option's premium.

  • Chapter Questions

    • Option premium equals $0.5 per barrel, and each contract specified a quantity of 1,000 barrels.
    • Compute the premium, and whether you will exercise this option if the market price is $50 per barrel?
    • Strike price of corn equals $5 per bushel; the option premium is $0.01 per bushel, and each contract specified a quantity of 100 bushels.
    • Calculate the farmer's premium, and whether he will exercise this option if the market price of corn equals $6 per bushel?

  • Default Risk and Bond Price

    • Economists call the difference between the interest rate on the U.S. government bonds and corporate bonds the default risk premium.Investors add default risk premium to a risk-free investment, so they can invest in "risky" bonds because they earn a greater return.
    • Risk premium is always positive.
    • As the default risk increases, then the risk premium increases too.
    • During recessions, when some businesses bankrupt, the default risk increases, increasing the risk premium.
    • Impact of a risk premium on the bond markets

  • Differences Between Required Return and the Cost of Capital

    • Instead of taking into account all types of securities issued by a firm, an investor acquires the appropriate required return by taking the risk-free rate and adding an investment specific risk premium.
    • The risk premium can be established by understanding business risk and financial risk.
    • Consequently, the risk premium consists of business risk + financial risk.
    • It adds the risk-free rate to the risk premium of the market adjusted to an investment's beta.

  • The Yield Curve

    • The expectation hypothesis of the term structure of interest rates is the proposition that the long-term rate is determined by the market's expectation for the short-term rate plus a constant risk premium.
    • The liquidity premium theory asserts that long-term interest rates not only reflect investors' assumptions about future interest rates, but also include a premium for holding long-term bonds (investors prefer short term bonds to long term bonds), called the term premium or the liquidity premium.
    • This premium compensates investors for the added risk of having their money tied up for a longer period, including the greater price uncertainty.
    • Because of the term premium, long-term bond yields tend to be higher than short-term yields, and the yield curve slopes upward.
    • Long term yields are also higher not just because of the liquidity premium, but also because of the risk premium added by the risk of default from holding a security over the long term.

  • Expected Risk and Risk Premium

    • The term risk premium refers to the amount by which an asset's expected rate of return exceeds the risk free rate.
    • The risk premium, along with the risk-free rate and the asset's Beta, is used as an input in popular asset valuation techniques, such as the Capital Asset Pricing Model.