Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 7 Risk Structure and Term...

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Chapter 7

Risk Structure and Term Structure of Interest Rates

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-2

Default Risk

• Default risk is measured relative to risk-free U.S. Treasury bonds.

• Default-risk premium = bond yield - yield on a comparable default-risk-free bond.

• The risk premium reflects in part the bond rating.


Table 7.1 Reading the Ratings Provided by Moody’s and Standard & Poor’s


Figure 7.1 Determining Default Risk Premium in Yields


Figure 7.2 Long-Term and Short-Term Yields in the United States, 1960–2006


Figure 7.3 Effect on the Risk Premium of a Decrease in Liquidity


Figure 7.4 Effect on Risk Premium of an Increase in Information Costs


Figure 7.5 Effect of Differences in Tax Treatment on Yields


Table 7.2 Risk Structure of Interest Rates


Yield Curve

• Yield curve is a graph of U.S. Treasury debt instruments as a function of maturity.

• Yield curve generally slopes upward.

• Yields on Treasury securities of different maturities have typically moved together.


Table 7.3 Theories of the Term Structure


Figure 7.6 Using the Yield Curve to Predict Interest Rates: The Expectations Theory


Figure 7.7 Interpreting the Yield Curve

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 7 Risk Structure and Term...

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