Suppose that a small, rural city in the countryside of North Dakota plans to issue $150,000 worth of 10-year bonds. Which one of the following components of the bond's yield will be affected by the fact that no active secondary market is expected for these bonds?

Question

Quizplus · Accepted Answer

The liquidity premium refers to the additional return that investors require to compensate for the lower liquidity of a security, compared to a similar security that has an active secondary market. Since no active secondary market is expected for the bonds issued by the small, rural city in North Dakota, the liquidity premium is likely to be higher, which will affect the overall yield of the bonds. The other components of the bond's yield, such as the real rate, interest rate risk premium, inflation premium, and taxability premium, are not directly affected by the absence of a secondary market.

Suppose That a Small, Rural City in the Countryside of North