Ch 7 - The Risk and Term Structure of Interest Rates I....

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The Risk and Term Structure of Interest Rates I. Introduction a. Changes in bond prices and the associated changes in interest rates, can have a pronounced effect on borrowing costs corporations face i. In 1998 we saw the simultaneous increase in some interest rates and decline in others- a rise in what are called interest rate spreads ii. Changes in the perceived risk of Ford and GM’s bonds led to decline in prices iii. This leads to increases in interest rates and higher corporate borrowing costs b. We must be able to distinguish among many different tyoes iof bonds that are traded in financial markets i. The Purpose of this Chapter is: 1. To examine how the issuer and time to maturity affect the price of a bond and 2. Use our knowledge to interpret fluctuations in a broad variety of bond prices II. Ratings and The Risk Structure of Interest Rates a. Default is one of the most important risks a bondholder faces b. In Fact, independent companies (rating agencies) have arisen to evaluate the creditworthiness of potential borrowers i. Estimate the likelihood that the corporate or government borrower will make a bond’s promised payments ii. The government has acknowledged a few firms as “nationally recognized statistical rating organizations” (NRSROs) III. Bond Ratings a. The best known bond rating services are i. Moody’s ii. Standard & Poor’s b. The monitor the status of individual bond issuers and assess the likelihood a lender will be repaid by the bond issuer c. A high rating suggests that a bond issuer will have little problem meeting a bond’s payment obligations
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This note was uploaded on 03/02/2011 for the course ECON 121 taught by Professor Labadie during the Spring '10 term at GWU.

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Ch 7 - The Risk and Term Structure of Interest Rates I....

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