T-bills and Risk Premium
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1. Why do US T-bills have lower interest rates than large-denomination negotiable CDs?
2. What would likely happen to the risk premium on corporate bonds if brokerage commissions were lowered in the corporate bond market?
3. If income tax exemption on municipal bonds were abolished, what would happen to the interest rates on these bonds? what effects would the change have on interest rates on US-Tbill?
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The solution answers a number of questions related to T-bills and risk premiums.
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Answer 1:
US T-bills have lower interest rates than large-denomination CD's because of the risk premium associated with T-bills. Remember the formula:
Interest Rates = US T-bills + Default Risk Premium
US T-bills are considered to be the safest investment out in the market because it is backed by US Federal government. Because of this, the risk premium is almost 0. Thus the interest rates ...
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