Question

At issuance, the yield or interest rate on a corporate bond security is comprised of ...

A	the quoted risk-free rate of return e.g., the Treasury Note rate.

B	the risk premium plus the risk-free rate ( e.g., the Treasury note rate).

C	the interest rate or rate of return in excess of the risk-free rate of return

D	the risk-free rate of return less the expected rate of inflation.

Answer 1

Correct option: B - the risk premium plus the risk free rate

The risk free rate is the rate paid on the Treasury notes (or other Treasury securities depending on the term of the bond) and since the issuer of the Treasury notes is a sovereign or country, it is deemed to be risk free since the chance of the government of the country defaulting on these notes is almost negligible.

Corporate bonds have a higher chance of defaulting than the government and hence, a risk premium is added to the risk free rate in order to represent this increased chance of default (than the country's government).

At the time of issuance of a corporate bond, the yield rate is a combination of the risk free rate and the risk premium specific to that issue of the corporate bond, thus, accommodating for both the risk of default by the corporate (risk premium) and the risk of default of the government at large (risk free rate).