RISK PREMIUM

MAJOR SOURCES
OF UNCERTAINTY
IN INVESTMENT

1
the less certain the income
BUSINESS RISK flow of the firm, the less
certain the income flows to
the investor.
is the uncertainty
of income flow Therefore, the investor will
demand a risk premium that
caused by the
is based on the uncertainty
nature of a firm's
caused by the basic business
business
of the firm

2
If a firm borrows
FINANCIAL RISK money to finance
investments, it must pay
Is the uncertainty fixed financing charges
introduced by the prior to providing income
method by which to the common
the firm finances stockholders, so the
its investments. uncertainty of returns to
the equity investor

3
increases.

LIQUIDITY An investor must consider two questions

RISK when assessing the liquidity risk :
Is the uncertainty (1) How long will
it take to convert
introduced the investment into cash?
(2) How certain is the price to be
by the
received? Similar uncertainty faces
secondary market an investor who wants to acquire
for an investment. an asset

4
EXCHANGE RATE RISK The more volatile the exchange
rate between two countries, the
Is the uncertainty less certain you would be
of returns to an
regarding the exchange rate,
investor who
the greater the exchange rate
acquires securities
risk, and the larger the
denominated in a
exchange rate risk premium you
currency different
would require.
from his or her own

5
COUNTRY(POLITICAL)
RISK
is the uncertainty of
returns caused by the
possibility of a major
change in the political or
economic environment of
a country.
Individuals who invest in
countries that have
unstable political-
economic systems must
add a country risk
premium when
determining their
required rates of return.

REFERENCE: https://www.google.com/amp/s/slideplayer.com/am
p/9068784/