outlook and longer-term bonds offer higher interest rates.oDown- sloping yield curve Sign of recessionShort term rates higher than long termoFlat yield curveNo incentive to do anythingYield curve-YTM: the price of moneyBorrower wants longer time bonds: large demand, little supply, price upInvestor wants shortertime : large supply, little demand, price downComponents of Interest RatesSpread to treasuries : -Risk free rate : short-term government of Canada T-bills in an inflation-free world.-Inflation : Average expected inflation rate over the life of the security.-Maturity premium: the longer the time of maturity, the higher probability bankruptcy, the lower the liquidity-Credit risk: the chance that interest or principal will not be paid on the due date and in the promised amount.-Liquidity premium: some bonds are easy to buy or sell, lower YTM-Callable/Puttable-legal-Convonents : Positive : what the company must do in order to put the bond into Negative: must not do-Tax:-Convexity-Currency riskTreasuryABBDevelopment countryRecession
-Reinvestment risk : all else equal, zero coupon bonds has lower reinvestment risk, lower YTM,Central banks affect rates:Discount Window :obanks use to borrow money from a central bank on a short-term basisoreduce liquidity problems for banks and assists in assuring the basic stability of financial markets. Open Market Operations: buy or sell government securities-Sell : people have less money, less propensity to lend, rate up-Buy: people have more money, want to lend money, the rate downQuantitive Easing -central bank purchases government securities or other securities from the market -lower interest rates and increase the money supply. -promote increased lending and liquidity. -when short-term interest rates are at or approaching zero,-does not involve the printing of new banknotes.Take it up or down :discount rate - overnight lending rate, market can adjust itselfCredit RatingsoAn assessment of the credit worthiness of a borrower in general terms or with respect to a particular debt or financial obligation. ocan be assigned to any entity that seeks to borrow money—an individual, corporation, state or provincial authority, or sovereign government. oCredit assessment and evaluation for companies and governments is generally done by a credit rating agency such as Standard & Poor’s, Moody’s or Fitch. oare paid by the entity that is seeking a credit rating for itself or for one of its debtissues.oNot investment risk, not investment analysisoS&P : AAA AA A BBB BB B CCC DAaa Aa A Baa Ba B Caaa DCanadian banks: AA--Investment Grade AAA AA A BBB-Non-Investment Grade, Junk, High-Yield BB B CCC-In Default, Distressed DoBankruptcy?
-Falling angle : A company’s bond from investment grade fall into non investment grade5 C’s of credit analysisoCharacter – Willingness to pay (determined by looking at the credit history)the credit score(FICO score)Late paymentsDelinquent accountsAvailable creditTotal debtoCapacity – Ability to pay Cash flow