05The Risk and Term Structure of Interest Rates

Chapter5TheRiskandTermStructureofInterestRatesChapterPreviewInthelastchapter,weexaminedinterestrates,butmadeabigassumption–thereisonlyoneeconomy-wideinterestrate.Ofcourse,thatisn’treallythecase.Inthischapter,wewillexaminethedifferentratesthatweobserveforfinancialproducts.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-2ChapterPreviewWewillfistexaminebondsthatoffersimilarpaymentstreamsbutdifferinprice.Thepricedifferencesareduetotheriskstructureofinterestrates.Wewillexamineindetailwhatthisriskstructurelookslikeandwaystoexamineit.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-3ChapterPreviewNext,wewilllookatthedifferentratesrequiredonbondswithdifferentmaturities.Thatis,wetypicallyobservehigherratesonlonger-termbonds.Thisisknownasthetermstructureofinterestrates.Tostudythis,weusuallylookatTreasurybondstominimizetheimpactofotherriskfactors.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-4ChapterPreview•So,insum,wewillexaminehowtheindividualriskofabondaffectsitsrequiredrate.Wealsoexplorehowthegenerallevelofinterestratesvarieswiththematurityofthedebtinstruments.Topicsinclude:–RiskStructureofInterestRates–TermStructureofInterestRatesCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-5RiskStructureofLongBondsintheU.S.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-6RiskStructureofLongBondsintheU.S.Thefigureshowtwoimportantfeaturesoftheinterest-ratebehaviorofbonds.•Ratesondifferentbondcategorieschangefromoneyeartothenext.•Spreadsondifferentbondcategorieschangefromoneyeartothenext.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-7Whatfactorsareresponsibleforthesephenomena?FactorsAffectingRiskStructureofInterestRates•DefaultRisk•Liquidity•IncomeTaxConsiderationsCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-8DefaultRiskFactor•Oneattributeofabondthatinfluencesitsinterestrateisitsriskofdefault,whichoccurswhentheissuerofthebondisunableorunwillingtomakeinterestpaymentswhenpromised.•U.S.Treasurybondshaveusuallybeenconsideredtohavenodefaultriskbecausethefederalgovernmentcanalwaysincreasetaxestopayoffitsobligations(orjustprintmoney).Bondslikethesewithnodefaultriskarecalleddefault-freebonds.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-9DefaultRiskFactor(cont.)•Thespreadbetweentheinterestratesonbondswithdefaultriskanddefault-freebonds,calledtheriskpremium,indicateshowmuchadditionalinterestpeoplemustearninordertobewillingtoholdthatriskybond.•Abondwithdefaultriskwillalwayshaveapositiveriskpremium,andanincreaseinitsdefaultriskwillraisetheriskpremium.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-10IncreaseinDefaultRiskonCorporateBondsCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-11AnalysisofFigure5.2:IncreaseinDefaultonCorporateBonds•CorporateBondMarket1.Reoncorporatebonds,Dc,Dcshiftsleft2.Riskofcorporatebonds,Dc,Dcshiftsleft3.Pc,ic•TreasuryBondMarket4.RelativeReonTreasurybonds,DT,DTshiftsright5.RelativeriskofTreasurybonds,DT,DTshiftsright6.PT,iT•Outcome–Riskpremium,ic-iT,risesCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-12DefaultRiskFactor(cont.)•Defaultriskisanimportantcomponentofthesizeoftheriskpremium.•Becauseofthis,bondinvestorswouldliketoknowasmuchaspossibleaboutthedefaultprobabilityofabond.•Onewaytodothisistousethemeasuresprovidedbycredit-ratingagencies:Moody’sandS&Pareexamples.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-13BondRatingsCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-14中国的债券评级机构？Application•P131,•Thestockmarketcrashof1987andthejunkbond-treasuryspread•P132,•Whatiftreasurysecuritieswerenolongerdefault-free?LiquidityFactor•Anotherattributeofabondthatinfluencesitsinterestrateisitsliquidity;aliquidassetisonethatcanbequicklyandcheaplyconvertedintocashiftheneedarises.Themoreliquidanassetis,themoredesirableitis(higherdemand),holdingeverythingelseconstant.•Let’sexaminewhathappensifacorporatebondbecomeslessliquid(Figure1again).Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-16DecreaseinLiquidityofCorporateBondsCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-17Figure5.2ResponsetoaDecreaseintheLiquidityofCorporateBondsAnalysisofFigure5.1:CorporateBondBecomesLessLiquid•CorporateBondMarket1.Liquidityofcorporatebonds,Dc,Dcshiftsleft2.Pc,ic•TreasuryBondMarket1.RelativelymoreliquidTreasurybonds,DT,DTshiftsright2.PT,iT•Outcome–Riskpremium,ic-iT,rises•Riskpremiumreflectsnotonlycorporatebonds'defaultriskbutalsolowerliquidityCopyright©2009PearsonPrenticeHall.Allrightsreserved.5-18LiquidityFactor(cont.)•ThedifferencesbetweeninterestratesoncorporatebondsandTreasurybonds(thatis,theriskpremiums)reflectnotonlythecorporatebond’sdefaultriskbutitsliquiditytoo.Thisiswhyariskpremiumissometimescalledariskandliquiditypremium.Copyright©2009PearsonPrenticeHall.Allrightsreserved.5-19IncomeTaxesFactor•AnoddfeatureofFigure1isthatmunicipalbondstendtohavealowerratetotheTreasuries.Why?•Muniscertainlycandefault.OrangeCounty(California)isarecentexamplefromtheearly1990s.•MunisarenotasliquidaTreasuries.Copyright©2009PearsonPrenticeHall.A