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3. Explain liquidity, default risk, and interest rate risk premiums.

3. Explain liquidity, default risk, and interest rate risk premiums.

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Answer #1

Liquidity premium is a premium added to the equilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to its "fair market value"


Default risk premium is the premium added to compensate for the risk that the issuer might default on the scheduled payments. In other words it is the difference between the interest rate on a US Treasury bond and a corporate bond of equal maturity and marketability

Interest rate risk premium is a premium that reflects interest rate risk; it is higher the greater the years to maturity. This is to compensate for the risk of capital losses to which investors are exposed because of changing interest rates.

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