The spread between the interest rate on risky bonds and default-free bonds is the:

Question

BlackTom AI · Accepted Answer

1. Relevant knowledge points and concepts
Risk premium is the extra yield investors demand to compensate for taking on additional risk relative to a default‑free security. Bond yields can be decomposed into a risk‑free rate plus premiums for inflation, maturity, liquidity, and credit/risk. The spread between the yield on a risky bond and a default‑free (risk‑free) bond isolates the compensation for risk — commonly called the risk premium (or credit/risk spread).

2. Step‑by‑step reasoning
- Let y_risky be the interest rate (yield) on a risky bond and y_safe be the yield on a default‑free bond of similar maturity.
- The spread S = y_risky − y_safe measures the additional return required by investors for accepting extra risk.
- By definition this additional return compensates for default probability, uncertainty about recovery, and other risk factors, and is called the risk premium.

3. Calculation example (intermediate steps)
- Suppose a default‑free bond yields y_safe = 3.0% and a risky corporate bond yields y_risky = 6.0%.
- Spread S = y_risky − y_safe = 6.0% − 3.0% = 3.0%.
- That 3.0% is the risk premium (the compensation for risk).

4. Why the correct answer is correct
The term “risk premium” precisely names the extra yield required for bearing risk. The question specifically asks for the spread between risky and default‑free bonds; that spread equals the risk premium (sometimes called the credit spread).

5. Why other options are incorrect
- a. default premium: narrower term sometimes used for compensation for expected default loss, but the standard, broader label for the full spread is risk premium. The exam’s intended term is risk premium.
- b. junk margin: informal and not a standard term in finance textbooks.
- d. bond margin: ambiguous and not the established name for the spread.

6. Conclusion
The spread between the interest rate on risky bonds and default‑free bonds is the risk premium. Final answer: c. risk premium.

The spread between the interest rate on risky bonds and default-free bonds is the:Single choice

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