The default-risk premium:
A) is negative for a U.S. Treasury bond.
B) is also known as the risk spread.
C) must always be greater than 0 (zero).
D) is assigned by a bond-rating agency.

Question

Quizplus · Accepted Answer

The default-risk premium is the additional return that investors demand to compensate for the risk of default on a bond. It is also known as the risk spread, which is the difference between the yield on a risky bond (such as a corporate bond) and the yield on a risk-free bond (such as a U.S. Treasury bond). Therefore, option B is the correct choice. Option A is incorrect because a U.S. Treasury bond is considered to be risk-free, so it does not have a default-risk premium. Option C is incorrect because the default-risk premium may sometimes be negative if investors are willing to accept a lower yield on a risky bond than on a risk-free bond. Option D is incorrect because the bond-rating agency assigns a credit rating to a bond indicating its creditworthiness but not the default-risk premium.

The Default-Risk Premium