An effect of interest rate risk and investment risk on a bond’s yield is classified as

The correct answer is: A. reinvestment premium.

A reinvestment premium is the additional return that an investor expects to earn on a bond due to the fact that the interest payments will be reinvested at a higher rate of interest. This premium is necessary to compensate the investor for the risk that interest rates may decline in the future and the investor will be forced to reinvest the interest payments at a lower rate of interest.

The other options are incorrect because:

• A maturity risk premium is the additional return that an investor expects to earn on a bond due to the fact that the bond has a longer maturity than a shorter-term bond. This premium is necessary to compensate the investor for the risk that the bond’s price will decline if interest rates rise.
• An investment risk premium is the additional return that an investor expects to earn on a risky asset, such as a stock, compared to a safe asset, such as a Treasury bond. This premium is necessary to compensate the investor for the risk that the risky asset will lose value.
• A defaulter’s premium is the additional return that an investor expects to earn on a bond that is issued by a company or government that is considered to be a risky borrower. This premium is necessary to compensate the investor for the risk that the bond issuer will default on its debt.