Maturity risk premium???!!!!?

Question

Which of the following statements is CORRECT?

If the maturity risk premium (MRP) is greater than zero, the yield curve must be upward sloping.

If the maturity risk premium (MRP) equals zero, the yield curve must be flat.

If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the yield curve will be upward sloping.

If the expectations theory holds, the yield curve will never be downward sloping.

Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.

Answer 1

Theoretically correct position is : Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds. But sometimes in real life, yield curves may be inverted or flat and higher maturity may not lead to higher risk premia. If the maturity risk premium (MRP) equals zero, the yield curve must be flat, provided there are no other effects like inflation risk premium.

It may be also true that "If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the yield curve will be upward sloping'.

It seems you are trying to find out the most incorrect statement . .

Note: The term structure of risk: risk varies with the maturity of a security

• Maturity risk premium: The longer the maturity of an asset, the

greater will be the effect on price of a given change in interest

rates. Long-term maturities are riskier than short-term maturities.

Hence the term maturity risk premium

• Inflation premium also has a term structure dimension. It will

likely vary with the maturity of an asset.

• At times, it will be higher for long- compared with short-term

securities.

• Other times, it will vary positively with maturity

• Inflation risk premium

• Analysis is in the developmental stage

• Logic suggests that there ought to be a term structure to the

inflation risk premium and it should be positive

• Maturity risk premiums

• Rise as economic condition deteriorate and vice versa

• Fall as financial confidence improves and vice versa

• Inflation premiums

• The term structure of the inflation premium will vary with

economic conditions

• Accelerating inflation will likely be associated with a

steepening of the term structure of the inflation premium

• Inflation risk premium

• The term structure of the inflation risk premium will also be

affected by developments in inflation, the credibility of

monetary policy and financial confidence