What Is a Maturity Risk Premium?

Maturity risk refers to the risk that is associated with uncertainty of interest rate. According to Financeglossary.net, the amount of the premium depends on the maturity of the bond. The longer it takes, the higher the amount of premium.

Function

The purpose of maturity risk premium (MRP) is to raise the interest rates specifically on long-term bonds as compared to the short-term bonds.

Calculation

Over the years, the maturity risk premium varies when the interest rates are more uncertain and volatile. When the interest rates are more stable, the maturity risk premiums fall.

Significance

Long-term bonds are more vulnerable to changes made in interest rates. The cash flows are generally received in distant future and thereby are more effected by the changes. For this reason, the maturity risk premiums increase with the time to maturity.

Range

According to "Fundamentals of Financial Management," from 2008 to 2010, the maturity risk premium on 20-year T bonds has been in the range of 1 to 2 percentage points.

Disadvantage

Unlike other premiums, maturity risk premium is difficult to calculate accurately.

References

• Finance Glossary: Maturity Risk Premium
• "Fundamentals of Financial Management": Maturity Risk Premium
• Net Files: Financial Problem

Resources

• Sabic Overview of Financial Management: Maturity Risk Premium