Please help What is a junk bond? What is the term structure of interest rates? W
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Question
Please help
What is a junk bond?
What is the term structure of interest rates? What determines its shape?
What is the Treasury yield curve?
What six components make up a bond’s yield?
AaBbCcDdE AaBbCcDdEe AaBbCcD mal No Spacing Heading 1 Heading 2 Title Subtitle Subtle Emp.. Emphas Investors Turn Finicky on Corporate Bonds High-grade corporate issuance is up, but for lower-rated firms, it has been a different story Bond-market turbulence in 2016 is widening the gap between corporate haves and have-nots, a dynamic that threatens to weaken the U.S. economic recovery by raising financing costs for lower-rated firms. The wealthiest companies have hardly missed a beat even as investors have retreated from risk and economic numbers have softened. Investors bought $12 billion in bonds Monday from triple- A-rated Exxon Mobil Corp., and Anheuser-Busch InBsy NV andApple Inc. also have completed blockbuster deals this year High-grade corporate issuance during the first two months of the year is up from the same period a year ago, when highly rated firms sold the most new bonds on record for the fourth year in a row, according to Securities Industry and Financial Markets Association data. But for lower-rated firms, it has been a different story. U.S. junk-bond issuance had its slowest start to the year since 2009, according to Dcalogic, and firms that have managed to sell bonds are paying a hefty price. Software firm Solera Holdings Inc. on Monday sold S1.7 billion of junk bonds to finance its buyout, after reducing the sale from a planned $2 billion. The firm also increased its interest rate and made several investor-friendly covenant changes, according to S&P; Global Market Intelligence The shift shows bond investors are getting pickier, focusing on low-risk bonds that are easy to trade. What's in: highly rated debt from the safest issuers and bonds from companies expected to be resilient in a slower economy. What's out: the energy sector, bonds from companies seen as needing a growing economy to thrive and bonds with longer maturities.Explanation / Answer
Junk Bonds
A junk bond is a fixed incoem security that offers a very high yeild to compensate teh investors for the high default risk. They are non investment grade bonds and hence have low credit ratings - a rating of BB or lower on S&P or Ba or lower by Moody's. They are mostly purchased for their speculative appeal.
Term Structure of Interest Rates
When you plot the prevailing market interest rates against a range of maturities, whatthe curve you will get is the term structure of interest rates.
There are mordern and traditional theories that explain the shape of the term structure.
Traditional theories:
Unbiased Expectation Theory: this theory proposes that the investor expectations determine the shape of term structure. The theory suggests that the forward rates are solely a function of expected future spot rates and that every maturity has the same expected return over a given investment horizon. which means that as an investor you will earn teh same return if you invest in a three year bond or if you invest in a 2 year nond and then in a 1 year bond. So basically you dont demand risk premiums according to the maturities
Local Expectations Theory
this theory states that oer longer periods risk premiums should exist and taht over short term horizon every bond should earn a risk free rate.
Liquidity Preference Theory
This theory proposes that the forward rates reflect investors'expectations of future spot rates plus a liquidity premium that compensates investors for the interest rate risk.and taht this liquidity premium is positively related to maturity,
Segmented markets theory
Under this theory the shape of the yeild curve is determined by prefernces of the borrowers and the lenders.
Prefered Habitat Theory
This one suggests that there is an imbalance between the supply and demand of funds in a given maturity range and thi s mbalance will case the investors to shift from one maturity range to the other. In order to make the investors to do so they have to be compensated. Borrowers would need lower yeilds while lenders require higer yeilds to move out of their preferred habitat.
MORDERN THEORIES
Cox Ingersoll Ross model is of the idea that at high interest rates the amount of period over period fluctuation in interest rates is also high
Vasicek model suggests that interest rates are mean reverting to the same long run value.
Treasury Yield Curve is the same concept as term structure of interest rates.
I am not sure about the components of bond yield but interest rates compreise of risk freee rate, liquidity premiums, maturity premium, premium for inflation risk, premium for default risk.