Do bond interest rate risk premiums only compensate for the amount investors might lose?
In answer to your last formulation, no. In a perfectly efficient market, different investors still have different risk tolerances (or utility functions). They're maximizing expected utility, not expected value.  The portfolios that maximize expected utility for different risk preferences are different, and thus generally have different expected values. (Look up mean-variance utility for a simple-ish example.)  Suppose you have log utility for money, u(x) = log(x), and your choice is to invest all of your money in either the risk-free bond or in the risky bond. In the risky bond, you have a positive probability of losing everything, achieving utility u(0) = -\infty. Your expected utility after purchase of the risky bond is:  Pr(default)*u(default) + (1-Pr(default))*u(nominalValue).  Since u(default)= -\infty, your expected utility is also negative infinity, and you would never make this investment. Instead you would purchase the risk-free bond.  But another person might have linear utility, u(x) = x, and he would be indifferent between the risk-free and risky bonds at the prices you mention above and might therefore purchase some. (In fact you probably would have bid up the price of the risk-free bond, so that the other investor strictly prefers the risky one.) So two different investors' portfolios will have different expected returns, in general, because of their different risk preferences. Risk-averse investors get lower expected value. This should be very intuitive from portfolio theory in general: stocks have higher expected returns, but more variance. Risk-tolerant people can accept more stocks and more variance, risk-averse people purchase less stocks and more bonds. The more general question about risk premia requires an equilibrium price analysis, which requires assumptions about the distribution of risk preferences among other things. Maybe John Cochrane's book would help with that---I don't know anything about financial economics. I would think that in the setup above, if you have positive quantities of these two investor types, the risk-free bond will become more expensive, so that the risky one offers a higher expected return. This is the general thing that happens in portfolio theory. Anyway. I'm not a financial economist or anything.  Here's a standard introduction to expected utility theory: http://web.stanford.edu/~jdlevin/Econ%20202/Uncertainty.pdf "[...] are all bonds priced in such a way so that they all return the same amount (on average), after accounting for risk? In other words, do risk premiums ONLY compensate for the amount investors might lose? No. GE might be able to issue a bond with lower yield than, say, a company from China with no previous records of its presence in the U.S. markets. A bond price not only contains the risk of default, but also encompasses the servicability of the bond by the issuer with a specific stream of income, location of main business, any specific terms and conditions in the prospectus, e.g.callable or not, insurances against default, etc. Else for the same payoff, why would you take a higher risk? The payoff of a higher risk (not only default, but term structure, e.g. 5 years or 10 years, coupon payments) bond is more, to compensate for the extra risk it entails for the bondholder. The yield of a high risk bond will always be higher than a bond with lower risk. If you travel back in time, to 2011-2012, you would see the yields on Greek bonds were in the range of 25-30%, to reflect the high risk of a Greek default. Some hedge funds made a killing by buying Greek bonds during the eurozone crisis. If you go through the Efficient frontier theory, your argument is a counter statement to it. Same with individual bonds, or a portfolio of bonds. You always want to be compensated for the risk you take. The higher the risk, the higher the compensation, and vice versa. When investors buy the bond at this price, they are essentially buying a ""risk free"" bond [...] Logically yes, but no it isn't, and you shouldn't make that assumption."
Firstly, I think you need to separate your question into two parts: If you are Chinese, live in China and intend to stay in China for most of your life then the default answer to question 1 should be Renminbi.  Question 2 is not as important, you can hold USD in almost any country in the world. Any investment you hold has risk, which may include market risk, credit risk, liquidity risk, inflation risk etc. Holding USD will expose you to exchange rate fluctuations as well.  If the Renminbi rises in value against the dollar your returns in USD will be reduced by the same amount (remember that for currency fluctuations you have to multiply the percentages, see here for a good explanation). The first thing you probably want to do is find out exactly what the assets are in the 理财 you have invested in.  The fact that there is a 'risk level' (even if it is only 2) would suggest to me that the fund is investing in some combination of bonds and stocks which means that your returns are not guaranteed and could make a loss. Interest rates on deposit accounts are mandated by the government in China, and the current 12 month deposit rate on RMB is 3%.  To earn over 3%, GEB must be investing your assets in something else (I'm guessing bonds).  Bear in mind that 1.5 years is a very short amount of time in investments, so don't assume this return will continue!  I'm afraid I've only been studying Chinese for a year, so I can't really help you much with the link you've sent through - you may want to check if there is any guaranteed minimum return, which can be the case in more complex structured products. Ultimately you will need to pick an investment which you feel gives you the best combination of risk and return for your situation, there are a huge amount of options to choose between.  The 4-5% you are earning right now is not a huge risk premium on the 3% you could earn in China from a time deposit, but in the current environment you may struggle to beat it without taking on more risk.  Before considering that though - understand how much risk you already have with GEB. "you want more information on what? The general bond market? This article is getting at something different, but the first several pages are general background info on the corporate bond market.  http://home.business.utah.edu/hank.bessembinder/publications/transparencyandbondmarket.pdf  If you are trying to relate somehow the issue of federal debt ( a la treasuries) to corporate debt you will find that you are jumping to a lot of conclusions.   Debt is not exactly currency, only the promise of repayment at a certain date in the future. The only reason that U.S. treasuries ( and those of certain other highly rated countries ) is interchangeable is because they are both very liquid and have very low risk.   There is very little similarity to this in the corporate bond market. Companies are no where near to the risk level of a government (for one they can't print their own money) and when a corporation goes bankrupt it's bondholder are usually s.o.l (recovery rates hover at around 50% of the notional debt amount). This is why investors demand a premium to hold corporate debt. Now consider even the best of companies, (take IBM ) the spread between the interest the government must pay on a treasury bond and that which IBM must pay on a similar bond is still relatively large.   But beyond that you run into a liquidity issue. Currency only works because it is highly liquid. If you take the article about Greece you posted above, you can see the problem generated by lack of liquidity. People have to both have currency and be willing to accept currency for trade to occur. Corporate bond are notoriously illiquid because people are unwilling to take on the risk involved with holding the debt (there are other reasons, but I'm abstracting from them). This is the other reason treasuries can be used as ""currency"" there is always someone willing to take your treasury in trade (for the most part because there is almost zero risk involved). You would always be much more willing to hold a treasury than an equivalent IBM bond.   Now take that idea down to a smaller level. Who would want to buy the bonds issued by the mom and pop down the street? Even if someone did buy them who would in turn take these bonds in trade? Practically speaking: no one would. They have no way to identify the riskiness of the bond and have no assurance that there would be anyone willing to trade for it in the future.   If you read the whole post by the redditor from your first link this is precisely why government backed currency came about, and why the scenario that I think you are positing is very unlikely." "It may seem weird but interest rates are set by a market. Risk is a very large component of the price that a saver will accept to deposit their money in a bank but not the only one. Essentially you are ""lending"" deposited cash to the bank that you put it in and they will lend it out at a certain risk to themselves and a certain risk to you. By diversifying who they lend to (corporations, home-buyers each other etc.) the banks mitigate a lot of the risk but lending to the bank is still a risky endeavour for the ""saver"" and the saver accepts a given interest rate for the amount of risk there is in having the money in that particular bank. The bank is also unable to diversify away all possible risk, but tries to do the best job it can. If a bank is seen to take bigger risks and therefore be in greater risk of failing (having a run on deposits) it must have a requisitely higher interest rates on deposits compared to a lower risk bank. ""Savers"" therefore ""shop around"" for the best interest rate for a given level of risk which sets the viable interest rate for that bank; any higher and the bank would not make a profit on the money that it lends out and so would not be viable as a business, any lower and savers would not deposit their money as the risk would be too high for the reward. Hence competition (or lack of it) will set the rate as a trade off between risk and return. Note that governments are also customers of the banking industry when they are issuing fixed income securities (bonds) and a good deal of the lending done by any bank is to various governments so the price that they borrow money at is a key determinant of what interest rate the bank can afford to give and are part of the competitive banking industry whether they want to be or not. Since governments in most (westernised) countries provide insurance for deposits the basic level of (perceived) risk for all of the banks in any given country is about the same. That these banks lend to each other on an incredibly regular basis (look into the overnight or repo money market if you want to see exactly how much, the rates that these banks pay to and receive from each other are governed by interbank lending rates called Libor and Euribor and are even more complicated than this answer) simply compounds this effect because it makes all of the banks reliant on each other and therefore they help each other to stay liquid (to some extent). Note that I haven't mentioned currency at all so far but this market in every country applies over a number of currencies. The way that this occurs is due to arbitrage; if I can put foreign money into a bank in a country at a rate that is higher than the rate in its native country after exchange costs and exchange rate risk I will convert all of my money to that currency and take the higher interest rate. For an ordinary individual's savings that is not really possible but remember that the large multinational banks can do exactly the same thing with billions of dollars of deposits and effectively get free money. This means that either the bank's interest rate will fall to a risk adjusted level or the exchange rate will move. Either of those moves will remove the potential for making money for nothing. In this case, therefore it is both the exchange rate risk (and costs) as well as the loan market in that country that set the interest rate in foreign currencies. Demand for loans in the foreign currency is not a major mover for the same reason. Companies importing from foreign entities need cash in foreign currencies to pay their bills and so will borrow money in other currencies to fulfil these operations which could come from deposits in the foreign currency if they were available at a lower interest rate than a loan in local currency plus the costs of exchange but the banks will be unwilling to loan to them for less than the highest return that they can get so will push up interest rates to their risk level in the same way that they did in the market before currencies were taken into account. Freedom of movement of foreign currencies, however, does move interest rates in foreign currencies as the banks want to be able to lend as much of currencies that are not freely deliverable as they can so will pay a premium for these currencies. Other political moves such as the government wanting to borrow large amounts of foreign currency etc. will also move the interest rate given for foreign currencies not just because loaning to the government is less risky but also because they sometimes pay a premium (in interest) for being able to borrow foreign currency which may balance this out. Speculation that a country may change its base interest rate will move short term rates, and can move long term rates if it is seen to be a part of a country's economic strategy. The theory behind this is deep and involved but the tl;dr answer would be the standard ""invisible hand"" response when anything market or arbitrage related is involved. references: I work in credit risk and got a colleague who is also a credit risk consultant and economist to look over it. Arbitrage theory and the repo markets are both fascinating so worth reading about!" "Who sets the prices? Effectively the market does, like basically all openly traded things. The Greek government could well have said ""5% is as high as we will go"".  As a result, investors may not have chosen to buy the securities.  The global bond market is highly liquid, and investors who have a choice could well then choose to go elsewhere. The reasons could well be varied, but primary among them would be that investors view Greek investments as more than 5% risky.  If I can get 5% from a country that I deem less risky than from Greece, my choice is clear.  Therefore to be compensated for loaning them my money, I am expecting a return of 7% because there is the possibility that they will default. As for not selling them at all, if they could avoid issuing bonds, most governments would.  They may not have had much of a choice.  If they just print more money, that does other potentially bad things to the economy.  The government needs funds to operate, if they are not collecting enough in taxes, for example, and do not want to print money as I mentioned, then bonds are one other common way to raise cash. Notwithstanding that in your example you are referring to the interest rate, not the price, the principal is the same." You are weighting a certain cost of the mortgage interest versus the possible gain of the value of the house.   Take the interest you pay per month and divide it by the current value of the house.  Say your interest is 3% of the value of the house (may be more or less depending on the balance owed and the interest rate of your mortgage). Say the average appreciation in your area is also 3%. But that means that there's only a 50% chance that the actual appreciation will be more than that (assuming the odds are equal either way), and there's a 50% change that you'll be worse off.   Generally, trading a risk-free loss for a risky gain of equal size is not a good investment; you generally can find better average returns on risky investments, so your best bet is to sell now and pay of the mortgage. "At the most fundamental level, every market is comprised of buyers and selling trading securities. These buyers and sellers decide what and how to trade based on the probability of future events, as they see it. That's a simple statement, but an example demonstrates how complicated it can be. Picture a company that's about to announce earnings. Some investors/traders (from here on, ""agents"") will have purchased the company's stock a while ago, with the expectation that the company will have strong earnings and grow going forward. Other agents will have sold the stock short, bought put options, etc. with the expectation that the company won't do as well in the future. Still others may be unsure about the future of the company, but still expecting a lot of volatility around the earnings announcement, so they'll have bought/sold the stock, options, futures, etc. to take advantage of that volatility.  All of these various predictions, expectations, etc. factor into what agents are bidding and asking for the stock, its associated derivatives, and other securities, which in turn determines its price (along with overall economic factors, like the sector's performance, interest rates, etc.) It can be very difficult to determine exactly how markets are factoring in information about an event, though. Take the example in your question. The article states that if market expectations of higher interest rates tightened credit conditions... In this case, lenders could expect higher interest rates in the future, so they may be less willing to lend money now because they expect to earn a higher interest rate in the future. You could also see this reflected in bond prices, because since interest rates are inversely related to bond prices, higher interest rates could decrease the value of bond portfolios. This could lead agents to sell bonds now in order to lock in their profits, while other agents could wait to buy bonds because they expect to be able to purchase bonds with a higher rate in the future.  Furthermore, higher interest rates make taking out loans more expensive for individuals and businesses. This potential decline in investment could lead to decreased revenue/profits for businesses, which could in turn cause declines in the stock market. Agents expecting these declines could sell now in order to lock in their profits, buy derivatives to hedge against or ride out possible declines, etc. However, the current low interest rate environment makes it cheaper for businesses to obtain loans, which can in turn drive investment and lead to increases in the stock market. This is one criticism of the easy money/quantitative easing policies of the US Federal Reserve, i.e. the low interest rates are driving a bubble in the stock market. One quick example of how tricky this can be. The usual assumption is that positive economic news, e.g. low unemployment numbers, strong business/residential investment, etc. will lead to price increases in the stock market as more agents see growth in the future and buy accordingly. However, in the US, positive economic news has recently led to declines in the market because agents are worried that positive news will lead the Federal Reserve to taper/stop quantitative easing sooner rather than later, thus ending the low interest rate environment and possibly tampering growth.  Summary: In short, markets incorporate information about an event because the buyers and sellers trade securities based on the likelihood of that event, its possible effects, and the behavior of other buyers and sellers as they react to the same information. Information may lead agents to buy and sell in multiple markets, e.g. equity and fixed-income, different types of derivatives, etc. which can in turn affect prices and yields throughout numerous markets." Disclaimer: I don't work in the finance industry, and simply took a few classes in corporate finance and management during my undergrad.  It depends on what type of investing you're talking about. If you're talking about building a portfolio of securities, then CAPM is the basis for most valuation models. Generally, CAPM will have you discount based on your best available risk-free rate (usually t-bills or some other fixed income source with a reliable backer). Even after your valuation, the basic theory of risk management for an investment portfolio is still to maintain a diverse basket of poorly correlated products.  If you're talking about corporate finance where a firm is considering an investment such as a new project, then a determining a WACC and using it as a discount rate for your cash flow is a basic strategy.   This is a basic strategy, but there are better ones depending on the specifics of the investment. This is where evaluating exposures is important. To hedge counterparty risk, you might discount by the estimated probability of non-payment or buy trade insurance. To hedge currency risk, you might buy forwards, options, or look into a money market hedge. To hedge political risks like repatriation or changes in tax laws or regulation you might buy political risk insurance. To hedge exposure to a particular commodity price, you can trade futures. "Even though the article doesn't actually use the word ""discount"", I think the corresponding word you are looking for is ""premium"". The words are used quite frequently even outside of the context of negative rates. In general, bonds are issued with coupons close to the prevailing level of interest rates, i.e. their price is close to par (100 dollar price). Suppose yields go up the next day, then the price moves inversely to yields, and that bond will now trade at a ""discount to par"" (less than 100 dollar price). And vice versa, if yields went down, prices go up, and the bond is now at a ""premium to par"" (greater than 100 dollar price)"