Compare the premium on high-yield corporate bonds (relative to Treasury bonds) at the beginning of the school term to the premium

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Compare the premium on high-yield corporate bonds (relative to Treasury bonds) at the beginning of the school term to the premium

Explaining bond premiums and price movements (from Chapter 8)

a. What is the difference between the yield on junk (high-yield corporate) bonds at the end of the school term and their yield at the beginning of the school term? Apply the concepts discussed in Chapter 8 to explain why this premium exists and why it changed over the school term.

Explaining bond premiums and price movements (from Chapter 8)

b. Compare the long-term Treasury bond yield at the end of the school term to the long-term Treasury bond yield that existed at the beginning of the school term. Given the direction of this change, did prices of long-term bonds rise or fall over the school term?

Explaining bond premiums and price movements (from Chapter 8)

c. Compare the change in the yields of Treasury, municipal, and corporate bonds over the school term. Did the yields of all three types of securities move in the same direction and by about the same degree? Apply the concepts discussed in Chapter 8 to explain why yields of different types of bonds move together.

Explaining bond premiums and price movements (from Chapter 8)

d. Compare the premium on high-yield corporate bonds (relative to Treasury bonds) at the beginning of the school term to the premium that existed at the end of the school term. Did the premium increase or decrease? Apply the concepts discussed in Chapter 8 to explain why this premium changed over the school term.

Answer & Explanation (1)

part a

Explanation
At the end of the school term, hunk bonds pay a higher yield than their safer counterparts to compensate investors for the accruing level of risks in the bonds acquired. Companies, however, need these bonds even with the higher chances that lead to higher yield because they want to attract investors to fund their operations.

Additionally, (Amadeo 2020) observes that companies are attracted to junk bonds to boost their overall returns while avoiding the higher volatility of stocks. This is mainly because they offer higher yields than investment-grade bonds. Secondly, junk bonds can de better if they are upgraded when the business is profitable. This means that the high yield bonds are not highly correlated to other bonds and can perform better in expanding the business cycle. This, therefore, means that junk bonds are a good investment to those who need a higher return and can afford to maintain the higher risks. However, junk bonds are vulnerable to interest rate increases meaning that the negative economic trends can catch even credit-worthy firms.

References

Amadeo, K. (2020). Why Would a Person Invest in Junk Bonds?. Retrieved 6 April 2021, from https://www.thebalance.com/what-are-junk-bonds-pros-cons-ratings-3305606

Chen, J. (2020). High-Yield Bond Definition. Retrieved 6 April 2021, from https://www.investopedia.com/terms/h/high_yield_bond.asp

Answer
According to (Chen 2020), junk bonds yield higher interest rates because they have a low credit rating compared to investment-grade bonds. The bonds are more likely to display and default higher price volatility. These bonds also have a higher risk than any other bonds issued by corporations or governments. They represent bonds given by companies that are financially struggling and have a higher risk of defaulting or not paying the principal to investors. These are debts that are issued by organizations to pay interest and to return the principal at maturity. High yield corporate bonds differ because of their issuers' more inferior credit quality (Amadeo, 2020). They carry higher risks since investors are uncertain whether they will be repaid their principal and earn regular interest payments. At the beginning of the school term, we observe that those buying junk bonds are more confident about the economy and are more than willing to take these risks. The main difference with the other bonds is that they have a high debt load relative to the earnings and cash flow.

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