Default risk makes bonds less attractive to savers

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Default risk makes bonds less attractive to savers. Issuers of high-risk bonds must offer high interest rates to attract buyers. Sovereign debt : bonds issued by national govt. Default risk on these bonds varies across counties. US have never defaulted on its bonds, and so its interest rates are low. Bond-rating agencies : firms that estimates default risk on bonds. Default Risk on Corporate Debt Corporations sometimes declare bankruptcy and default on their bonds. Junk bonds : corporate bond with ratings below BBB. High-yield spread: difference between two interest rates: rates on corporate bond with BBB rating and with AAA ratings Liquidity Asset holders value liquidity because they might need to raise money quickly in an emergency. Govt bonds are more liquid than corporate bonds. Less liquid bonds pay higher interest rates due to the difficulty of selling them. Taxes Most relevant for interest rates on municipal bonds(bonds issued by state and local govt) Interest on municipal; bonds are tax free. Encourages savers to buy munipical bonds. Pays lower interest rates CHAPTER 5 PARTICIPANTS IN SECURITIES MARKETS Investment : production of physical capital : factories Saving: when you buy securities. Players in securities markets can be individuals, firms, and other financial institutions Individual Owners In 2007, individuals directly owned 28% of U.S corporate bonds Individuals owned most of the 25% of stocks held by mutual funds. Growth of individual stock ownership is due to the growth of 401k plasn that’s channel workers’ retirement savings into securtities. Securities Firms Primary purpose is to hold securities, trade them, or help others trade them. Several types of securitie firms : mutual funds, hedge funds, brokers and dealers, and investment banks. Mutual Fund Financial institution that holds a diversified set of securities and sells shares to savers. Each shareholder owns a small part of all the securities in a fund. Buying mutual fund shares is a way to diversify assets. Reduces risk. Each fund hold different kinds of stocks and bonds, other specialize. (treasure bonds, corporate bonds, stocks issued by largers or smaller firms, hold u.s securites, or foreign. Hedge Fund Raise pools of money to purchase securities. They cater only to wealthy people and institutions. Most require clients to contribute $1 million or more. Govt regulation is key difference between this and mutual fund. To protect small savers, the govt limits the risks that mutual funds can take with shareholders money. Hedge funds are largely unregulated, b.c the govt assumes that the funds’ rich customers can look out for themselves.

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