Which best describes a risk premium?

A risk premium is best described as an increment above the risk-free rate of return. This concept is central to investment and finance as it represents the additional return investors require for taking on the extra risk associated with an investment compared to a risk-free asset. The risk-free rate is typically associated with government bonds, which are considered safe investments; thus, the risk premium compensates investors for the uncertainties associated with other investments, such as stocks or real estate, which may have variable returns.

The risk premium reflects various factors, including market volatility, economic conditions, and asset-specific risks. Understanding the risk premium is crucial for investors as it helps them evaluate potential investments and make informed decisions regarding risk and return.