Question

What is the significance of the risk premium in developing an investor's nominal interest rate on a corporate bond? How does the risk premium affect the bond's coupon interest rate?

Answer 1

Risk premium is important in developing the investors nominal interest rate on a corporate Bond because it is determining the premium for the risk which has been taken by the investor for investment into a corporate Bond rather than a Treasury Bond because treasury bond is reflecting the risk free rate of return and there are risk related to investment into the corporate bonds which will be risk related to higher interest rate risk along with higher liquidity risk and higher default risk and all these risks are to be accumulated in the risk premium in order to determine the nominal rate of interest which will be above the real rate of interest.

Risk premium will always be affecting the coupon rate of interest because risk premium will be embedded into the coupon rate of interest as when there will be a higher is associated with the investment then there will be a higher coupon rate which will be provided by the company in order to lure investor to invest into those companies so risk premium will be a determining the coupon rate of various bonds.