o Down sloping yield curve Sign of recession Short term rates higher than long

O down sloping yield curve sign of recession short

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outlook and longer-term bonds offer higher interest rates. o Down- sloping yield curve Sign of recession Short term rates higher than long term o Flat yield curve No incentive to do anything Yield curve - YTM: the price of money Borrower wants longer time bonds: large demand, little supply, price up Investor wants shorter time : large supply, little demand, price down Components of Interest Rates Spread 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 risk Treasury A BB Development country Recession
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- Reinvestment risk : all else equal, zero coupon bonds has lower reinvestment risk, lower YTM, Central banks affect rates: Discount Window : o banks use to borrow money from a central bank on a short-term basis o reduce 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 down Quantitive 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 itself Credit Ratings o An assessment of the credit worthiness of a borrower in general terms or with respect to a particular debt or financial obligation. o can be assigned to any entity that seeks to borrow money—an individual, corporation, state or provincial authority, or sovereign government. o Credit assessment and evaluation for companies and governments is generally done by a credit rating agency such as Standard & Poor’s, Moody’s or Fitch. o are paid by the entity that is seeking a credit rating for itself or for one of its debt issues. o Not investment risk, not investment analysis o S&P : AAA AA A BBB BB B CCC D Aaa Aa A Baa Ba B Caaa D Canadian banks: AA- - Investment Grade AAA AA A BBB - Non-Investment Grade, Junk, High-Yield BB B CCC - In Default, Distressed D o Bankruptcy?
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- Falling angle : A company’s bond from investment grade fall into non investment grade 5 C’s of credit analysis o Character – Willingness to pay (determined by looking at the credit history) the credit score ( FICO score ) Late payments Delinquent accounts Available credit Total debt o Capacity – Ability to pay Cash flow
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