429week02f07 - Week 2: Sep 3 Bond Risk Credit Risk Interest...

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Week 2: Sep 3 Bond Risk Credit Risk Interest Rate Risk Modeling Tools
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Bond Risk Credit Risk Risk of non-pmt: function of time and quality What determines credit quality? Other debt, seniority, industry, growth, macro- environment, profitability, solvency/liquidity Indenture Provisions (Covenants), guarantees SP Investment Grade: AAA, AA+/-, A+/-, BBB+/- Moody’s: Aaa, Aa1/3, A1/3, Baa1/3 Yield is proportional to risk Normal: Upward slope (down a bit for longest) Inversion often means recession about a yr later
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Bond Risk Why do we care if we are not FI investors? Relation Yield Curve Theories Expectations Theory: Upward slope means that future short rates will be higher than they are now. Ignores price risk: bond prices may change over time Ignores reinvestment risk: ability to reinvest if rollover Liquidity Theory: longer holding period, more risk Market Segmentation: Different demands for different maturities LTCM and 30 yr OTR treasury Short-term demand (demand deposits and cash mgmt) vs long term (pension funds need safer investments)
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Bond Risk Bond Market Breakdown of Debt (Bns) 2Q 2004 Muni, 1,959.30, 9% Treas, 3,755.30, 16% Mortgage, 5,357.50, 23% Corporate, 4,569.90, 20% Agency, 2,725.20, 12% MM, 2,648.10, 12% Asset-backed, 1,771.50, 8%
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Bond Risk US Treasuries (June 2004) T-Bills: $946,759 MM (<1 yr) T-Notes: $2,052,221 MM (1 yr-10 yr) T-Bonds: $555,923 MM (20,30 yr, callable) Money Market CD: Time deposit, guaranteed by FDIC
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This note was uploaded on 04/06/2008 for the course H ADM 429 taught by Professor Cchang during the Fall '03 term at Cornell University (Engineering School).

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429week02f07 - Week 2: Sep 3 Bond Risk Credit Risk Interest...

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