Which of the following mainly leads to the annual rate of return of 5-year government bonds higher than 3-month government notes?

Question

BlackTom AI · Accepted Answer

Maturity-risk premium (also called the term premium) arises because longer-term bonds expose investors to greater interest-rate and price risk, so they demand a higher yield.

1. Relevant knowledge points and concepts
- Nominal bond yield can be decomposed: nominal yield = real risk-free rate + expected inflation + default-risk premium + liquidity premium + maturity (term) premium.
- Maturity (term) premium compensates investors for interest-rate risk (price volatility when rates change) and reinvestment risk over a longer horizon.
- Government short-term securities (e.g., 3-month notes) and longer-term government bonds (e.g., 5-year) have essentially the same sovereign default risk and are both highly liquid, so differences in yield primarily reflect term/maturity risk and possibly inflation expectations.

2. Step-by-step reasoning
- Compare a 5-year government bond to a 3-month government note. Both share the same issuer (so default-risk premium ≈ 0 for both).
- Liquidity: 3-month Treasury bills are extremely liquid, but 5-year Treasuries are also very liquid. Liquidity differences exist but are small relative to the extra compensation needed for duration exposure.
- Inflation risk: longer maturities do have more uncertainty about future inflation, which can raise yields somewhat. However, this effect is captured partly in expected inflation and partly in the term premium.
- The dominant additional yield component required for longer maturity is the maturity (term) premium — compensation for price volatility if market interest rates change over five years and for uncertainty about reinvestment rates.

3. Calculations / intermediate steps
- Conceptual decomposition: y_5yr = y_real + E[inflation_5yr] + default_premium + liquidity_premium + term_premium.
- Since default_premium ≈ equal and liquidity_premium ≈ similar, the extra y_5yr − y_3mo ≈ higher term_premium (+ some inflation uncertainty).

4. Why the correct answer is correct
- The maturity-risk (term) premium directly explains why longer-term government bonds yield more than short-term notes: investors require extra return for bearing additional duration and interest-rate risk.

5. Why other options are incorrect
- a. Liquidity-risk premium: Both are very liquid; liquidity differences are small and not the main driver.
- b. Default-risk premium: Same sovereign issuer, so little-to-no difference in default risk.
- d. Inflation risk premium: Contributes but is not the main, primary reason; the term premium (maturity risk) is the principal factor.

6. Conclusion
- Therefore, the correct answer is c. Maturity-risk premium, which matches the provided answer.

Which of the following mainly leads to the annual rate of return of 5-year government bonds higher than 3-month government notes?单项选择题

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