Question

Classify default premium, liquidity premium, and information premium

Answer 1

Default premium:

A default premium is defined as the additional amount that is paid by the borrower to compensate the lender for assuming the default risk. All companies or borrowers generally pay a default premium through the rate at which they have to repay the obligation.

Investors often measure the default premium as the yield on an issuance over & above a government bond yield of similar coupon & maturity. For example a company issues a 10 year bond, an investor can compare this to an us Treasury bond of 10 year maturity.

The more the revenue a company can generate, higher its credit rating will be & higher the credit rating, lower will be is its default premium.

Liquidity premium:

A liquidity premium is the term for the additional yield of an investment that cannot be readily sold at its fair market value. The liquidity premium is responsible for the upward yield curve typically seen across interest rates for bond investments of different maturities.

Liquidity premium is a premium demanded by investors when any given security cannot be easily converted into cash for its fair market value. When the liquidity premium is high, the asset is said to be illiquid, and investors demand additional compensation for the added risk of investing their assets over a longer period of time since valuations can fluctuate with market effects.

Information premium:

No information available about information premium in any of the sources.