Q. 1 The amount of additional interes... [FREE SOLUTION]

Chapter 6: Q. 1 (page 190)

The amount of additional interest investors receive due to various risk premiums changes over time. Sometimes risk premiums are much larger than at other times. For example, the default risk premium was very small in the late 1990s when the economy was so healthy that business failures were rare. This risk premium increases during recessions
Go to http://www.federalreserve.gov/releases/h15 (historical data), and find the following three interest rate listings for AAA- and Baa-rated bonds: the most current listing; the listing for January 5, 2018; and the listings for June 1, 2008, and June 1, 2007. Prepare a http://www.federalreserve.gov/Releases/h15/update/ The Federal Reserve reports the yields on different-maturity U.S. Treasury bonds. graph that shows the interest rate information for these bonds over these three time periods (see Figure 1 for an example). Are the risk premiums stable, or do they change over time?

Short Answer

Expert verified

The risk premiums have been changing over time.

Step by step solution

Definition

Risk premium is the additional financial, paid over and above the return on the risk free assets it is a monetary reward tot the investor for bearing the risk.

Explanation

In the country US, the great depression officially lasted from December $2007$ to June $2009$ . The investors were willing to stay in the market. While the three months treasury bill implied a short-term investment, the investment in the long-term assets is rewarded with a higher risk premium during the recessionary phase of an economy. The investor who chose to purchase or stay with BAA corporate bond was given the highest return in the form of the risk premium as interest listings as stated. The corporate bond yield was highest during the period of depression ending June $2009$ . The investment in long-term government bonds too was high yield investment at that time since shattering public confidence was keeping funds away from the market. This is again illustrated in the plummeting interest figures against the government bonds particularly during the initial year of depression from $Q 2 2007 t o Q 3 2008 .$

As the economy entered the stage of recovery, the financial assets became safer to put money into. This is reflected in the gradually falling interest rates from $5.59$ percent in October to $1.89$ percent in October $2017$ for BAA corporate bonds and from $4.84$ percent to $2.84$ percent for long-term treasury bonds during the same period. Thus the risk premium is responsive to the level of economic activity.