Chapter 6 Interest Rates 179Interest Rate
(%)121086420 10 20 30
Years to MaturityBBB-Rated Bond
AA-Rated BondTreasury BondIllustrative Corporate and Treasury Yield Curves
F I G U R E 6! 6INTEREST RATETerm to Maturity Treasury Bond AA-Rated Bond BBB-Rated Bond
1 year 5.5% 6.7% 7.4%
5 years 6.1 7.4 8.1
10 years 6.8 8.2 9.1
20 years 7.4 9.2 10.2
30 years 7.7 9.8 11.1
almost no chance that Coca-Cola will go bankrupt over the next few years. However,
Coke has some bonds that have a maturity of almost 100 years; and while the odds
of Coke defaulting on those bonds might not be very high, there is still a higher
probability of default risk on Coke’s long-term bonds than its short-term bonds.
Longer-term corporate bonds also tend to be less liquid than shorter-term bonds.
Since short-term debt has less default risk, someone can buy a short-term bond with-
out doing as much credit checking as would be necessary for a long-term bond.
Thus, people can move in and out of short-term corporate debt relatively rapidly. As
a result, a corporation’s short-term bonds are typically more liquid and thus have
lower liquidity premiums than its long-term bonds.
Figure 6-6 shows yield curves for two hypothetical corporate bonds—an AA-
rated bond with minimal default risk and a BBB-rated bond with more default risk—
along with the yield curve for Treasury securities taken from Panel a of Figure 6-5.
Here we assume that in" ation is expected to increase, so the Treasury yield curve is
upward-sloping. Because of their additional default and liquidity risk, corporate
bonds yield more than Treasury bonds with the same maturity and BBB-rated bonds
yield more than AA-rated bonds. Finally, note that the yield spread between corporate
and Treasury bonds is larger the longer the maturity. This occurs because longer-term