Chapter 7 review Flashcards
2 crucial differences about bonds:
- Identity of Issuer
- Time to Maturity
Best known Bond rating services:
- Moody’s
- Standard & Poor’s
Which companies receive high bond ratings?
Companies with low levels of debt, that are highly profitable, and have many assets.
Two Types of Junk Bonds
-Fallen Angels: Were once investment-grade bonds. -Little is known about the risk of the issuer.
Benchmark Bonds:
US treasuries
Bond Yield
U.S. Treasury + Default risk premium (risk spread)
Taxes:
Investors make decisions based on an after-tax yield.
Commercial Paper
Short term bond usually less than 270 days. Only the most creditworthy companies can issue these.
Taxes related to bonds & Governments:
The interest income on a bond are not taxed twice.
Tax exempt Bond yield =
(Taxable bond Yield) * (1 - Tax Rate)
Difference between short and long term bond yields
Short term bonds are more volatile Long term bond yields are generally higher
Expectations Hypothesis:
Bonds of different maturities are perfect substitutes for each other. -YTM on a long term bond represents the average YTM that investors expect on short - term bonds over that period. Explains 1st and 2nd fact of the Yield Curve.
3 Facts about the Yield Curve
1- Yields on bonds with similar characteristics but different times to maturity tend to move together (positive correlation) 2- Yields on short term bonds are more volatile than Long-term bonds. 3- The Yield curve tends to slope upwards
The Yield Curve is related to what?
A crystal ball to predict recessions.
Liquidity Premium Theory
-Technically: Illiquidity drives yields higher. -Practically: Bonds with longer times to maturity will have higher YTM’s because these bonds have loner durations (and higher interest rate risk.) -Explains Fact #3
