ECON 302 Chapter Notes -Economic Equilibrium, Risk Premium, Corporate Bond

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The risk and term structure of interest rates. Risk structure of interest rates (what determines its interest rate) y default risk: one aspect of a bond that influences the interest rate is the risk of default. this occurs when the issuer of a bond is unable or unwilling to make interest payments when promised. the issuer could also not pay off the face value when the bond matures: could have to corporations suffering big losses are likely to suspend payments on bonds. therefore, their default risk would be quite high: some bonds, like sovereign bonds such as us treasury bonds, have almost no risk, because they can always raise taxes to pay them off. these are called default-free bonds: the spread between the interest rates of bonds with default risk and the default- free bonds is called the risk premium.