Logo of the KNOW NOW newsletter, composed of the letters of the word itself, and with reference to Financial Education, a BBVA and Funds People partnership. Logo of the KNOW NOW newsletter, composed of the letters of the word itself, and with reference to Financial Education, a BBVA and Funds People partnership.

What does premium mean?

Mário Pires | Schroders

Head of Portugal
In this position, Mário Pires is responsible for meeting the interests and needs of intermediary and institutional clients in Portugal, as well as growing the business in the region.

December 2025 by Mario Pires

In common parlance, "premium" is used as a synonym for quality, to differentiate products or services that stand out, for example, through exclusivity, innovation, or performance. This meaning is close to the origin of the word: The Latin word praemium, meaning reward or advantage. 

In Portuguese, the Latin word praemium became prêmio (prize), and similar terms are used in many other languages around the world. “Premi” in Indonesia or “premija” in Croatia are just two examples. The English adopted "premium," and that's the term that became associated with the financial sector.

In the financial sector, the insurance industry was a pioneer and, historically, used the word "praemium" to specify that, in insurance, the policyholder must pay a premium to the party who assumes a risk on their behalf. Even today, when we take out insurance, the premium is the amount we pay to compensate the insurer for the risk it assumes on our behalf.

Four types of investment premiums and what they mean.

In investment, the word has a meaning close to its root and is used generically to designate an amount that exceeds the intrinsic or fundamental value of an asset, and may represent compensation related to risk and opportunity for return. There are at least four specific applications:

1 - Bond premium:

The term "bond premium" is used when an issuer sells bonds at a rate higher than that available for similar bonds on the market, or when their price on the secondary market is higher than their face value.

If the bond's interest rate is higher than the rates offered in the market, investors are more willing to pay an additional amount – a premium – to secure a more attractive interest stream. 

2 - Risk premium:

The risk premium is the additional return that investors expect to obtain when investing in risky assets, such as stocks, corporate bonds, or commodities (compared to risk-free options, such as deposits, or lower-risk options, such as Treasury bonds).

The greater the uncertainty (risk) associated with the return that an asset can provide, the higher the risk premium, that is, the reward demanded by investors.

3 - Illiquidity premium:

Investing in private assets (venture capital, infrastructure, or private debt, for example) typically requires a longer period for the invested capital to be tied up, and it is in this context that the illiquidity premium is discussed. 

This means that, in order to accept having their money tied up for a longer period, sometimes several years, investors demand additional compensation. This award has been one of the reasons why large institutional investors have increased their exposure to private markets.

4 - Option premium: 

A financial option is a contract that gives the buyer the right, but not the obligation, to buy or sell an asset at a fixed price up to a specific date. The amount that the buyer pays the seller to exercise this right is called the option premium. In the derivatives market, the term refers to the price paid for a call option or a put option on a wide variety of assets: Stocks, commodities, currency, indices, and exchange-traded funds (ETFs), for example.

The premium on options represents an opportunity cost: the chance to benefit from a favorable market development without bearing the full risk of owning the asset. For example:

  • Instead of buying 100 shares of company Y at a unit price of €50 (total €5000), an investor buys a call option that gives him the right to acquire them at the same price within a period of three months. This option pays a premium of €1 per share (€100). 
  • If, before the deadline, the shares rise to €55, it makes sense to exercise your option right: You buy it for €5000 and can sell it for €5500. He earns €500 and, after deducting the €100 for the option right, he profits €400.
  • But if the shares fall to €45 (€4500), it's better not to exercise your option right, as you would have to buy the shares for the agreed €5000, losing €400. Therefore, you only lose the €100 premium from your option.

In conclusion, a premium can represent opportunity, but it also signifies risk. Understanding the meaning of different types of premiums helps to evaluate this relationship, improving the potential return on investment.