Assume interest rates on 10-year government Treasury Notes (T-Notes) and 10-year Corporate Bonds are as follows: T-Notes = 3.85% AAA = 4.50% A = 4.95% BBB = 5.65%. The differences in rates among these issues are caused primarily by

a. Liquidity risk differences.
b. Maturity risk differences.
c. Inflation differences.
d. Default risk differences.

The correct option is D,default risk differences

Explanation:

Default risk is the risk which stems from the fact that the borrower might fail to discharge its obligation in paying  interest and principal  as and when due as  contained in the debt contract agreement.

The investor is expected to be compensated for default risk,in other words,highly risky investment pays a spread over and above risk free investment return.

Government Treasury Notes are risk-free,pays zero compensation for default  risk, while corporate bonds that more riskier pays a little extra to entice investors to invest in their bonds,otherwise the planned amount expected from bond issuance would not be realized.

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