Question

the yield on a 9 month treasury bond 2.3 % the yield on a three year treasury bond is 2.9% and the yield on a ten year treasury bond is 4.3%. although no liquidity premium is associated with treasury securities, there is a mrp for treasuries with maturities equal to one year or greater. what is the mrp?

Answer 1

what is MRP?

sol:- First of all, the full form of MRP is maturity risk premium. any investment for less than a year is known as short term investment. For long term investment, there will always a risk for losing value before the maturity. Bonds or treasuries bill are nothing but lending to the government or the company by the bold or treasury bill holder. Government or company or bond issuer is obliged to pay the interest in the form of coupons and at maturity pay the sum in full.

Now the question come here is holding a t-bill or a bond is safe or not for longer period or what period could be considered as safe for holding these types of financial instruments. Bonds for maturity of 2 years considered safer than holding a bond for 30 year time period. why is it so? this is because, increase in time period increases the volatility or probability of interest rate fluctuation by getting it increased. This can lead to reduction in the value of the bond or t-bill. For this reason, investor need incentive to purchase long term bonds.

Here come the Maturity Risk Premium into the picture. MRP is the extra amount of return that an investor anticipate in his investment by purchasing a long term bond or t-bill. MRPs are mainly designed to compensate the investors for taking on the risk for holding the bonds or t-bills over a long period of time. in short, longer the time period higher will be the maturity risk premium.