Characteristic Component Symbol it changes over time, depending on the expected
ID: 2812139 • Letter: C
Question
Characteristic Component Symbol it changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people's time preferences for consumption. This is the premium added to the risk-free rate that reflects the average sustained increase in the general level of prices for goods and services expected over the security's entire life This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing It is calculated by adding the inflation premium to r It is based on the bond's rating; the higher the rating, the lower the premium added, thus lowering the interest rate As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for thisExplanation / Answer
All components in these are basically constituents of interest rate on a security
Nominal Yield = Real risk free rate + Inflation premium + Maturity Risk Premium + Liquidity Risk Premium + Default Risk Premium
The term names in order and their symbols are in brackets.
1. Real risk free rate (r*) - minimum return an investor requires when inflation not considered
2. Inflation Premium (IP) – this is the component added to yield to compensate investor for the risk of price rise over the tenure of bond.
3. Liquidity Premium (LP) - term for the additional yield of an investment that cannot be readily sold at its fair market value.
4. Nominal Yield (r) – term for risk free rate that is adjusted for inflation.
5. Default Risk Premium (DRP) – this accounts for risk or probability of default by the bond issuer on its coupon or face value
6. Maturity Risk Premium (MRP) - designed to compensate investors for taking on the risk of holding bonds over a lengthy period of time.