Interest Rate Risk

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The interest rate risk structure for interest rates is called the Risk Premium or Risk Spread. It is the extra interest that a risky asset must pay relative to a risk-less asset since investors demand compensation for taking on higher risk.

Interest Rate Risk Structure

Highly rated investment-grade bonds are those with the lowest risk of default. Junk Bonds have the highest risk premium and are at the highest risk of default. Junk Bonds are anything below Ba, a.k.a non-investment grade.

  • Interest on T-Bonds is exempt from State and local taxes but not federal taxes.
  • Interest on corporate bonds (& other private assets) taxable at every level – federal, state, local.
  • Interest on municipal bonds, not taxed within the home state. These bonds have lower yields than bonds whose interest payments are taxable.

Bond ratings by Moody’s, S&P and Fitch.

Bonds Interest Rate Risk Structure

Interest Rate Risk Structure Example

Interest Rate Risk Premium

Risk Premium = Interest (riskier asset) – Interest (treasury bond)

Ex: T-bonds pay 5% int. after-tax, Corp bond pay 8% after-tax

Risk Premium = 3%

Prateek Agarwal
Prateek Agarwal
Member since June 20, 2011
Prateek Agarwal’s passion for economics began during his undergrad career at USC, where he studied economics and business. He started Intelligent Economist in 2011 as a way of teaching current and fellow students about the intricacies of the subject. Since then he has researched the field extensively and has published over 200 articles.

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