The Risk Structure of Interest Rates?

Question

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The risk structure of interest rates studies the behavior of interest rates for bonds with the same term to maturity but different risk characteristics. Which of the following combinations of bonds provides the best situation to study the risk structure of interest rates?

A. A three-month Treasury bill vs. a 30-year Treasury bond

B. A 30-year Treasury bond vs. a corporate Aaa bond

C. A six-month Treasury bill vs. a corporate Aaa bond

D. Six-month commercial paper vs. a seven-year Treasury note

E. Three-month commercial paper vs. a corporate Baa bond

Answer 1

The best combination to observe the risk structure is option B: a 30 year Treasury bond and a corporate Aaa bond. The reason for this is simple. A 30 year Treasury bond and a corporate Aaa bond have similar terms so the term structure is constant, therefore, the primary difference is the risk structure. To further explain this answer I'll eliminate the other options.
Option A does not work because they are the same type of security--government securities--so they have the same risk (which, by the way, is virtually zero).
Option C does not work because those bonds of vastly different terms--6 months vs. about 30 years
Option D does not work because those bonds are also of vastly different terms--6 months vs. 7 years
Option E does not work because they are both vastly different terms and they are the same type of security--corporate debt

Therefore, Option B is the correct choice because it compares different types of securities (government vs. corporate) of similar terms (about 30 years).

Answer 2

None.

A. A three-month Treasury bill vs. a 30-year Treasury bond
Both securities are Treasury securities and thus can be used to study TERM structure of interest rates, not RISK structure.

B. A 30-year Treasury bond vs. a corporate Aaa bond
The maturity of the corporate bond is not stated, so comparing these two bonds may result in mixing term structure and risk structure inferences if their maturities are different. It could be your answer, if the maturity of the corporate bond were reasonably close to 30 years.

C. A six-month Treasury bill vs. a corporate Aaa bond
Same as B above, only maturity mispatch is not a possibility, but a guarantee.

D. Six-month commercial paper vs. a seven-year Treasury note
Same as C above.

E. Three-month commercial paper vs. a corporate Baa bond
Both securities are corporate and thus can be used to study TERM structure of interest rates, not RISK structure.