Certified Financial Management Specialist Practice Exam

Which term describes the additional yield for longer-term securities compared to short-term?

1. Liquidity Premium (LP)

2. Maturity Rate Premium

3. Default Risk Premium (DRP)

4. Inflation Premium (IP)

The correct answer is: Maturity Rate Premium

The correct term that describes the additional yield for longer-term securities compared to short-term is known as the Maturity Rate Premium. This concept stems from the fact that investors typically demand a higher return for tying up their money for an extended period, as longer maturities expose them to greater risks such as interest rate risk and uncertainty regarding the economic environment over time. When an investor chooses to invest in a longer-term security, they face risks that short-term investments do not, including the possibility of rising interest rates that could affect the market value of existing bonds. This added uncertainty encourages investors to seek a premium, or additional yield, as compensation for assuming these risks. Other terms listed do not appropriately reflect this specific concept. The Liquidity Premium refers to the additional yield that compensates investors for holding securities that are not easily tradable. The Default Risk Premium relates to the additional yield an investor requires to bear the risk that the issuer may default on its debt obligations. Lastly, the Inflation Premium represents the yield that compensates for expected inflation over the investment period. While all these premiums affect bond yields, they do not specifically address the phenomenon of yield related solely to the duration of the investment, which is captured by the Maturity Rate Premium.