Understanding the Maturity Risk Premium in Fixed-Income Investments

Fixed-rate securities incorporate a maturity risk premium when setting the interest rate.

When you invest in securities that pay you a fixed rate of interest, such as a fixed-rate bond or certificate of deposit, both you and the borrower are stuck with the agreed-upon interest rate for the term of the security. If the market interest rates go up, you still receive the lower agreed-upon rate, even though it's less than the market rate. The risk that rates will rise above the set rate is known as interest rate risk.

Maturity Risk Premium

The maturity risk premium takes the interest rate risk one step further by increasing the market rate for securities with longer terms to account for the risk that the interest rate will increase. This premium is larger in long-term securities than short-term securities. For example, if your certificate of deposit is only a year, the chances that interest rates change drastically isn't as high as the risk on a five-year certificate of deposit, so the five-year CD will have the higher maturity risk premium.