FIN 2650 Lecture Notes - Lecture 14: United States Treasury Security, Five Guys, Risk Premium
20 Jan 2020
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Risk-free rate: real rate of return return if no expected inflation and no risk. Inflation risk premium compensates investor for the risk that future purchasing power will be lower due to expected inflation: treasury inflation protected securities (tips) provide an estimate of inflation expectations. Maturity (interest-rate) risk premium: compensates investor for greater risk that results from longer term investments. Seniority (priority) risk premium: compensates investor for risk from lower ranking position in claimant structure, bonds = first in line; stocks = last in line. Compensates investor for risk that asset might not be quickly and easily sold. Example: order the following investment opportunities from safest (1) to most risky (5). Mcdonald"s has higher default risk than the u. s. government. Five guys is a much smaller company; less liquid liquidity risk premium. Stockholders are in a position of lower priority; lower seniority exposes stockholders to additional risk.
