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Maria Juarez is a professional tennis player, and your firm manages her money. She has asked...

Maria Juarez is a professional tennis player, and your firm manages her money. She has asked you to give her information about what determines the level of various interest rates. Your boss has prepared some questions for you to consider.
a) In determining interest rates we have discussed the terms real risk-free rate, inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP). Which of these premiums is included in determining the interest rate on (1) short-term Treasury securities,
(2) long-term Treasury securities,
(3) short-term corporate securities, and
(4) long-term corporate securities?

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Answer #1

(1). Short term treasury securities includes only inflation premium

(2). Long term treasury securities inflation premium and maturity risk premium. This is because the longer the period to maturity, the longer the maturity risk

(3). Short term corporate securities rate is equal to real risk free rate plus inflation premium, default risk premium and liquidity premium. As the securities belong to corporate, we should expect default risk and liquidity risk as well.

(4). Long term corporate securities rate is equal to real risk free rate plus inflation premium, default risk premium, liquidity premium and maturity risk premium. Along with the other risks maturity risk should be considered because of the longer period to maturity.

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