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Class 8 Revised Chapter 7 Risk and Term Structure Discussion

Class 8 Revised Chapter 7 Risk and Term Structure...

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Class 8 Chap 7: Risk structure and Term Structure Discussion Risk Structure : maturity held constant—compares yields across issuers I. Understand the purpose and reasons for Bond ratings a. Know the meaning of investment grade bonds and ratings range: S&P ( AAA – BBB); Moody’s (Aaa – Baa) b. Know the meaning of junk bonds ( below Baa or BBB) b.i. Understand fallen Angel b.ii. Understand flight to quality and its consequences. b.ii.1. Decreases yields on Treasuries and increases yields on corporate bonds b.ii.2. This causes business cost of capital to increase II. Understand yield spread : Treasuries are the “benchmark” or standard for quoting bonds. Corporate Bonds are usually quoted on a “spread” basis as a benchmark treasury + a spread which the risk or default premium. a. Graph effects of an increase in risk on spreads on yields on corporate bonds b. Compare treasury yields to Aaa and Baa yields (See Fig 7.2) c. Compare T-bills to Commercial paper ( See fig 7.2) Corporate Spread S & D toolkit To show the effects of “flight to quality”, select and move the curves to the place on the axis you
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