Question

2 Risk shock and bonds market,

Use the market of corporate bonds and government bonds to graphically show how will riskaffects the risk spread defined as the difference between the corporate bond yields and thegovernment bond yields.

Answer 1

The government bonds like T-bills do not have any maturity risk, default risk or liquidity risk. Only long term Treasury bonds have some small amount of maturity risk because their long term nature. Hence we can call government bonds as risk free securities.

On the other hand, the corporate bonds do have several risks which include the credit risk which is also defined as default risk, the liquidity risk along the maturity risk. Hence the yields of corporate bonds are always higher than that of government bonds. Hence these have a higher yield. The graph is shown below between a government bond and a corporate bond which explains this more clearly: