(BBA)CH6 Risk and Term Structure

(BBA)CH6 Risk and Term Structure - Chapter Six The Risk and...

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Chapter Six The Risk and Term Structure of Interest Rates
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Risk & Term Structure of Interest Rates (p.123) Risk Structure of Interest Rates: Bonds with the same term to maturity have different interest rates. The relationship among these interest rates is called risk structure of interest rates. Term Structure of Interest Rates: Bonds with the different term to maturity have different interest rates. The relationship among these interest rates is called term structure of interest rates.
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Risk Structure of Interest Rates (p.123) Why do bonds with same maturity have different interest rates? 1. Default Risk 2. Liquidity 3. Income Tax Considerations
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Default Risk (p.124- 125) Default-free bonds: Bonds with no default risk. US Treasury bonds are considered to have no default risk because federal government can increase taxes to repay off its obligations. Risk Premium : The spread between the interest rates on bonds with default risk and default-free risk. A bond with default risk will have positive risk premium, and an increase in its default risk will raise risk premium.
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Default Risk (p.125) If default risk of corporation bonds increases, expected return on corporation bonds will decrease. Thus, demand curve shifts to the left. Price of bonds                                                      Price of bonds                    D1                    S                                   D1               D2            S    D2      P P                                     Q * Q *                        Quantity of Corporate bonds                                        Quantity of T-bonds
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Bond Rating (p.126)  
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Moody's accumulative probability of default (1920-2007) Source: Moody's investor service Rating Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Aaa 0 0 0.019 0.077 0.163 0.255 0.368 0.531 0.701 0.897 Aa 0.061 0.181 0.286 0.446 0.704 1.013 1.336 1.651 1.953 2.294 A 0.073 0.237 0.500 0.808 1.116 1.448 1.769 2.131 2.504 2.901 Baa 0.288 0.850 1.561 2.335 3.142 3.939 4.707 5.475 6.278 7.061 Ba 1.136 3.200 5.315 7.490 9.587 11.560 13.363 15.111 16.733 18.435 B 4.047 8.786 13.494 17.720 21.425 24.656 27.594 30.037 32.154 33.929 Caa-C 13.728 22.460 29.029 33.916 37.638 40.584 42.872 44.921 46.966 48.981 Inv 0.144 0.431 0.805 1.230 1.687 2.517 2.626 3.091 3.578 4.076 Spec 3.590 7.237 10.572 13.919 16.714 19.179 21.372 23.336 25.114 26.827 All 1.406 2.878 4.315 5.626 6.802 7.584 8.803 9.667 10.484 11.281
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Moody's accumulative probability of default (1920-2007) Source: Moody's investor service   Rating Year 11 Year 12 Year 13 Year1 4 Year 15 Year1 6 Year 17 Year1 8 Year 19 Year 20 Aaa 1.073 1.12 1.363 1.411 1.452
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This note was uploaded on 11/07/2010 for the course BBA 4565 taught by Professor Chushunhe during the Spring '10 term at University of Macau.

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(BBA)CH6 Risk and Term Structure - Chapter Six The Risk and...

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