Question

1. If we were given a corporate spread for AAA bond as 1.4%, can we produce the yield curve for AAA bonds simply assuming a vertical distance of 1.4% over the Treasury yield curve?

2. What do you think is the best way to calculate the Maturity Risk Premium?

Answer 1

Solution:

1. If we have the treasury curve for the same maturity as the corporate bond then we can produce the yield curve using the treasury yield curve. It is given that the spread for the corporate bond is 1.4%, then we can add this spread to the treasury curve yield to find the yield curve of the bond. If the maturities are different then we cannot produce the same

2. The maturity risk premium is the risk associated with the bond that has higher maturity. We can calculate the maturity risk premium by using this method

Step 1: Find the treasury bond yield (Maturity 10 years ). Suppose this is 2%

Step 2: Find the treasury bill yield (Maturity 1 year). Suppose this is 0.5%

Step 3: Subtract the treasury bill fro treasury bond ( 2% - 0.5%) = 1.5%

This will be the maturity risk premium for the bond having 10 years of maturity.