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Name and describe three risk premiums that may be reflected in a bond’s yield to maturity.

Name and describe three risk premiums that may be reflected in a bond’s yield to maturity.

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Answer #1

The three risk premium in bond's yield to maturity are as follows:-

i) Default risk premium = This premium is given to compensate the investor for any likelihood of default from the entity on their debt. It is basically a difference between a debt instrument interest rate and the risk free rate.

ii) Liquidity premium= This premium is given for illiquidity of the bond. Illiquidity means the bonds which are not traded actively.

iii) Maturity risk premium= This risk premium is given for holding the bond for longer period of time.

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