- Relationship between bonds with same term to maturity and their different interest rates is called the risk structure.
- Default risk is the risk that the borrower (i.e. issuer) will fail to meet its interest payment obligations.
– Some borrowers may have greater risk of default. (i.e. private sector firms)
– Government bonds are assumed to have zero default risk. As they are risk-free, they offer a risk-free rate of return
– Investors will require compensation for bearing the extra default risk
For different securities, their varying default risks will have an impact on their yield curves