That would reduce demand for mortgage paper, in addition to embedding a risk premium in the rate for those investors still willing to take the gamble.
Because that risk is not passed on to pension beneficiaries (their benefits are guaranteed, whatever the market does) it is improper to use a liability discount rate that includes the risk premium.
There would, on the other hand, be a useful fall in interest rates, because investors would no longer demand a premium for the risk that the exchange-rate peg would be broken.
Long bonds usually have higher coupons than short ones, as investors demand a premium for exposure to the risk of interest-rate rises and inflation.
Mr. BRIAN MONTGOMERY (Federal Housing Commissioner, U.S. Department of Housing and Urban Development): And that's the main difference between FHA and the subprime, is we price for the risk with an insurance premium, whereas in most of the subprime world, they price the risk in the interest rate.
Bonds pay interest based on the expected inflation rate until maturity, plus a fair risk premium over inflation based on the riskiness of the bond.
The remaining yield on longer-term bonds is a risk premium that is commensurate with U.S. interest-rate volatility (Japanese risk premiums are lower, but they also have nearly zero interest-rate variability).
Banks should like it because interest-only mortgages earn a premium rate and they get to lock in low-risk assets at their current depressed values.
One challenge when evaluating tech stocks in this particular segment is finding a discount rate (required rate of return) that includes enough of a risk premium.
Given the historic relationship between the risk premium and economic growth, the market is currently forecasting a growth rate over the next few years of about 1%.
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The average risk premium on the country's bonds has fallen from a peak of 18 percentage points above the interest rate on United States' Treasury bonds to below six.
As a result the most important variables to the price of an asset are the level and future shape of free cash flows, and the discount rate used, which, as you rightly point out, can be analysed in terms of risk premium.
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