A bond with default risk will always have a positive risk premium and an increase in its default risk will raise the risk premium.
The difference between the interest rate on a debt instrument and the risk-free rate is basically the default risk premium. Investors are given a discount for the possibility of a default by a company through the default risk premium.
The return on risk-free investment is subtracted from the return on investment to determine the risk premium. A rough estimate of the expected returns on a moderately hazardous investment in comparison to those gained on a risk-free investment can be obtained using the Risk Premium formula.
Formula for Risk Premium: Ra - Rf
Consider risk premium as a type of investment insurance. A worker assigned to risky labor anticipates receiving hazard pay as payment for the risks they assume. It's comparable to making risky investments. For an investor to be willing to take on the risk of losing some or all of their cash, a risky investment must have the potential for higher returns.
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