Subject 8. Credit and Liquidity Risk

A change in yield-to-maturity will cause a change in bond price. What is the source of the change in the yield-to-maturity?

The yield-to-maturity on a corporate bond has two components:

  • Government benchmark yield. A change in the yield can come from a change in either of these two components:

    • Expected inflation rate.
    • Expected real rate of interest.

  • A spread over government benchmark. A change in the spread can come from a change in either of these two components:

    • Credit risk of the issuer. This involves the probability of default and degree of recovery if default occurs.
    • Liquidity of the bond. This refers to the transaction costs associated with selling a bond.

Regardless of the source of the yield-to-maturity change, the bond price change caused by a change in the yield-to-maturity will be the same.

In practice, there is often interaction between changes in benchmark yields and in the spread over the benchmark.

User Contributed Comments 8

You need to log in first to add your comment.
Luminos: I think breaking the LOS into segments this way makes debt instruments much easier to study
cong: Flight to quality means that investors would be more interseted in low-return low-risk investments in times of turbulence.
2014: This chapter here in analyst notes is explained in good way
johntan1979: I totally agree... from dentures to stripping to spreading... Analyst Notes rocks!
gill15: Im getting way to tired....all I read was stripping to spreading and something rocks....

time to hit the club...
enetis: im with you gill
farhan92: now this makes sense !
fobucina: gill that was the best comment i've read so far