Final answer:
The interest rate risk premium is the compensation investors demand for accepting interest rate risk. The interest rate of risk premium is the additional compensation that investors demand for accepting the risk of fluctuating interest rates.
Step-by-step explanation:
The interest rate risk premium is the compensation investors demand for accepting interest rate risk. When investors buy bonds, they expect to receive a rate of return. However, bonds vary in the rates of return they offer based on the riskiness of the borrower. The interest rate risk premium is the additional compensation that investors demand for accepting the risk of fluctuating interest rates. For example, if an investor buys a long-term bond with a fixed interest rate right before market interest rates rise, they may have missed out on the opportunity to receive a similar bond with a higher interest rate. Therefore, they would require a risk premium to compensate for the potential loss in value due to interest rate changes.
The interest rate risk premium is the additional return that investors require to compensate them for the risk associated with changes in interest rates. As interest rates fluctuate, the prices of fixed-income securities (such as bonds) may also change, impacting the overall return that investors receive. Investors demand an interest rate risk premium to compensate for this uncertainty and risk.