Chapter 6

Chapter 6 - Chapter 6-The Risk and Term Structure of...

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Chapter 6 - The Risk and Term Structure of Interest Rates Risk Structure of Interest Rates •Bonds with the same maturity have different interest rates due to: –Default risk –Liquidity –Tax considerations •Default risk: probability that the issuer of the bond is unable or unwilling to make interest payments or pay off the face value –U.S. Treasury bonds are considered default free (government can raise taxes). –Risk premium: the spread between the interest rates on bonds with default risk and the interest rates on (same maturity) Treasury bonds Response to an Increase in Default Risk on Corporate Bonds Risk Structure of Interest Rates •Liquidity: the relative ease with which an asset can be converted into cash –Cost of selling a bond –Number of buyers/sellers in a bond market •Income tax considerations –Interest payments on municipal bonds are exempt from federal income taxes. Interest Rates on Municipal and Treasury Bonds
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Term Structure of Interest Rates •Bonds with identical risk, liquidity, and tax characteristics may have different interest rates because the time remaining to maturity is different
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Chapter 6 - Chapter 6-The Risk and Term Structure of...

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