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Chapter 7 - The risk and term structure of interest rates. The purpose of this chapter is: To examine how the issuer and time to maturity affect the price of a bond, and to use our knowledge to interpret fluctuations in a broad variety of bond prices. | Chapter Seven 7- Introduction Changes in bond prices and the associated changes in interest rates, can have a pronounced effect on borrowing costs corporations face. In 1998 we saw the simultaneous increase in some interest rates and decline in others - a rise in what are called interest rate spreads. Changes in the perceived risk of Ford’s and GM’s bonds led to declines in prices. This leads to increases in interest rates and higher corporate borrowing costs. 7- Introduction We must be able to distinguish among many different types of bonds that are traded in financial markets. The purpose of this chapter is: To examine how the issuer and time to maturity affect the price of a bond, and To use our knowledge to interpret fluctuations in a broad variety of bond prices. 7- Ratings and the Risk Structure of Interest Rates Default is one of the most important risks a bondholder faces. In fact, independent companies (rating agencies) have arisen to evaluate the . | Chapter Seven 7- Introduction Changes in bond prices and the associated changes in interest rates, can have a pronounced effect on borrowing costs corporations face. In 1998 we saw the simultaneous increase in some interest rates and decline in others - a rise in what are called interest rate spreads. Changes in the perceived risk of Ford’s and GM’s bonds led to declines in prices. This leads to increases in interest rates and higher corporate borrowing costs. 7- Introduction We must be able to distinguish among many different types of bonds that are traded in financial markets. The purpose of this chapter is: To examine how the issuer and time to maturity affect the price of a bond, and To use our knowledge to interpret fluctuations in a broad variety of bond prices. 7- Ratings and the Risk Structure of Interest Rates Default is one of the most important risks a bondholder faces. In fact, independent companies (rating agencies) have arisen to evaluate the creditworthiness of potential borrowers. These companies estimate the likelihood that the corporate or government borrower will make a bond’s promised payments. The government has acknowledged a few firms as “nationally recognized statistical rating organizations” (NRSROs). 7- Bond Ratings The best known bond rating services are Moody’s Standard & Poor’s They monitor the status of individual bond issuers and assess the likelihood a lender will be repaid by the bond issuer. A high rating suggests that a bond issuer will have little problem meeting a bond’s payment obligations. 7- Bond Ratings Firms or governments with an exceptionally strong financial position carry the highest ratings and are able to issue the highest-rated bonds, Triple A. Ex: U.S. Government, ExxonMobil, Microsoft The top four categories are considered investment-grade bonds. These bonds have a very low risk of default. Reserved for most government issuers and corporations that are among the most financially
