The risk premium is one of the most important parameters to determine the evolution of the stock markets. Not surprisingly, investors look at it every day to determine the decisions they are going to make to make their savings profitable. However, in the first place it will be necessary to know what this important economic term actually means. Well, the risk premium is first of all that the difference between interest that is requested to the debt issued by a country whose assets have greater risk compared to another risk-free.
In any case, and to better understand its real meaning, you must know that this type of premium is better known among a good part of investors such as risk from a country. Because in effect, nothing less and nothing more than measures the risks that a nation can go through, whatever it may be. And it has been so well known for the events that has developed during the recent economic crisis, where every day the first thing that all financial intermediaries did was to verify what the risk premium in Spain was. Because to a large extent, and depending on its evolution, the stock market fell or rose with more or less intensity.
One of the keys to the risk premium is how its calculation is carried out, since sometimes it generates the odd problem to arrive at the percentage of this important economic data. Well, the Spanish risk premium, like that of any other country in our environment, calculated by subtracting the interest paid on ten-year bonds Spanish the interest paid on German bonds in basis points. Because in effect, this German bond is the reference point to determine what its level is at all times. With a rather different impact, depending on its evolution.
Link to German debt
To determine the risk premium it is very important to bear in mind that not only does the weakness of the Spanish debt count, but also the strength of the German debt. In this performance, there is a lot of money that passes from hand and many winners and losers. It is one of the issues that will bring out in this article. Because it can help you take positions in one or another financial asset. To the point that you can earn a lot of money, but for the same reasons, leaving excessive euros on the road. It is a tribute that must be paid to the risk premium of a country, in this case Spain.
Within this general scenario, the risk premium is listed on the financial markets as if it were a financial asset since at the end of the day it is. With constant variations every day and that in the end determine the profitability of the investments. In this sense, it represents a greater benefit for the investor in exchange for assuming greater risk. As you will see, the word risk is always present in all their actions, as on the other hand it is logical to understand. And in a way, it has been installed in the dictionary of a good part of the small and medium investors. In one way or another, as is natural and otherwise understandable.
Risk premium: its levels
At this time it will be completely necessary to know why the risk premium is at one level or another. Well, when it is said that the risk premium in Spain is at levels of 100 basis points, it means that there is no risk for the national economy. In other words, it is a really favorable scenario for economic activity. With a very clear impact on the equity markets by favoring the stock exchanges keep an uptrend as a consequence of this diagnosis. Where purchases are imposed with great clarity on sales. It is definitely news that is very well received by all economic intermediaries and investors could not be absent among them.
On the contrary, when the risk premium is out of control, such as above 400 basis points, it has a completely opposite meaning. It is actually the result of the fact that the risks are very high and great efforts must be made to change this trend or economic cycle. As can be understood, the financial markets do not take this fact very positively and there are frequent drops in bags, even with a special intensity. More or less it is a reflection of what Spain happened at the beginning of the economic crisis, around 2012 and 2013, when its risk premium reached truly alarming levels.
Effects of a high risk premium
It is time to analyze its repercussions on the economy of a country and especially when this level of contribution is very high. Because its implications are more relevant than you might believe from the beginning. Directly affecting the pocket of the consumers themselves. But it is time for you to verify what its most important effects are and how you can notice them from now on.
- A considerable rise in the risk premium over our country is also reflected in the more immediate reality of companies. Not surprisingly, it implies a higher cost of your financing. To the point that it can cause unemployment to increase by not being able to assume a large part of its production.
- One of the most direct effects of this scenario is that interest increases considerably and as a consequence of this trend the state will have to reserve much more money to be able to pay them. This in practice means that there will be less money for social spending, infrastructure, technology and other kinds of services and benefits. It is not the best scenario, therefore, for the majority of citizens since the state will tend to an economic policy based fundamentally on savings.
- Of course, a rise in the risk premium is not good news for employment, far from it. Because in effect, according to calculations made by the banking sector, it is indicated that for every 100 basis points that the risk premium increases, about 160.000 jobs are created in Spain. Therefore, by highlighting a clear relationship between a high risk premium and the employment generation in a country. As has happened in Spain in recent years, where this economic parameter has gone from 500 to less than 100 basis points in a few years, as is happening right now.
Less credits and more expensive
Nor can we forget another fact that has an important reflection in society and is derived from the need to finance itself in the usual marketing channels, in this sense, banks will have to pay more money to get financed and this fact is immediately passed on to the user. This reality implies that the granting of credit lines is slowing down and that conditions are much worse than until now. In other words, the client will have no choice but to pay higher interest to be able to finance himself. In other words, both parts of the process will be clearly affected by this trend in the risk premium.
On the other hand, the fact that consumption is slowing down with great intensity is also very relevant. There is less money moving and as a consequence of them the main economic constants of a country are harmed. Up to levels that can be very dangerous for everyone. Namely, lower economic growth and more unemployment as some of the most important variables and that are noticed by a good part of the agents of the society. It is a very negative spiral that does not have any positive points, as we are indicating in this article.
Money seeks other markets
Nor can it be forgotten that when these scenarios are generated, money changes hands. This basically means that investment flows try to find other financial markets that offer them greater security and peace of mind. Usually towards more stable squares, as for example the German or North American. It is a reflection that money at this time has no country, but rather seeks its own profitability, above other technical considerations. And of course, in these scenarios it is not the best profitability that they can find.
This is another motivation for large investors to move their money to other equity markets. With a selling pressure on the price of the shares since the lack of buyers affects this special trend to occur and is identified by small and medium investors. Because there is no doubt that purchases can be made with prices more adjusted to the new reality. Beyond the possible rallies that may occur in the national financial markets, under one intensity or another. Not surprisingly, it is another added risk that investors have.