Finance Questions?

Question

What is the difference between the maturity risk premium and the liquidity risk premium?

Answer 1

Maturity Risk Premium measures the extra return an investor would require for buying a security with a longer maturity.  Say you're comparing 10-year T-Bill to a 30-year T-Bill.  The return on the 30-year would have to be higher than the 10-year because it has a longer maturity.  The longer the  maturity, the higher the MRP due to the rising uncertainty of not receiving repayment.

Liquidity Risk Premium measures how much return investors require for purchasing a less-liquid asset.  For example, consider a U.S. Treasury Bond and a Ford Inc. Bond with the same maturity, coupon payments, etc.  Since the U.S. Bond is the most liquid (will never default), the Ford Bond will have a higher return because it is riskier and would become very illiquid should it go bankrupt.