Risk Structure of Interest Rates

Risk Structure of - Risk Structure of Interest Rates From Last Time The world real interest rate is an equilibrium interest rate Unless we are

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Risk Structure of Interest Rates From Last Time The world real interest rate is an equilibrium interest rate. Unless we are there, market forces drive the rate to its equilibrium level. Default Risk Interest rates on credit market instruments vary because of differences in 1. default risk 2. liquidity 3. information costs 4. taxation 5. length of time to maturity The first 4 items comprise the risk structure of interest rates. Default risk is the chance that a borrower will not pay in full the promised interest, principal, or both. Default risk is so important to investors, yet so difficult for them to estimate directly, that borrowers pay bond-rating firms such as Moody's and Standard & Poor's to evaluate their debt. S&P rates bonds currently paying interest from AAA (prime quality with lowest default risk) to C (highly speculative). Bonds in default are rated D. Lenders demand an interest premium to compensate them for losses in the event of default on interest or principal. This is called the risk premium. The risk premium makes the expected
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This note was uploaded on 11/22/2011 for the course FIN FIN1100 taught by Professor Bradrifkin during the Fall '09 term at Broward College.

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Risk Structure of - Risk Structure of Interest Rates From Last Time The world real interest rate is an equilibrium interest rate Unless we are

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