Final answer:
Corporate bonds are more risky than U.S. Treasury bonds, which is why they offer higher interest rates to compensate for the increased default risk. Yields on both types of bonds tend to fluctuate together, but corporate bonds always pay a premium over U.S. Treasury notes and bank accounts.
Step-by-step explanation:
The risk premium on corporate bonds reflects the fact that they have a higher default risk compared to U.S. Treasury bonds. In the context of the options provided, the appropriate answer is that corporate bonds are more risky than U.S. Treasury bonds. This greater risk is why corporate bonds typically offer a higher interest rate as compensation to investors for taking on the additional uncertainty associated with the ability of corporate entities to fulfill their bond obligations.
While both corporate bonds and 10-year U.S. Treasury notes, also known as T-notes, have yields that tend to move together in the financial markets, the yields on corporate bonds are generally higher to cover the default risk. Unlike the federal government, which is considered a very safe borrower, corporations have a greater chance of failing to make their bond payments, leading bondholders to potentially demand bankruptcy proceedings to recover their investments. Even corporate bonds with an AAA rating by Moody's, indicating a relatively safe borrower status, still carry a higher risk compared to U.S. Treasury bonds.
In sum, the higher interest rates offered by corporate bonds serve as an incentive for investors to take on the additional risk, over and above the interest rate provided by safer investments like U.S. Treasury bonds or bank accounts. This is a key concept in understanding the difference between various bond types and the assessment of investment risk