This is a graded discussion: 40 points possible Chapter 7 Discussion By the end

Question

This is a graded discussion: 40 points possible Chapter 7 Discussion By the end of Chapter 7, you should understand: due Se . credit risk and bond ratings the yield curve and the relationship of bond maturities to yields , how yields inform future expectations of investment return and value This discussion question has several parts. Give each explanation in a complete paragraph form. Your post is worth up to 30 points. . When responding to the posts of others, pick one item that you can add significant thought to and address that concept in your post. Each of two responses you make are worth up to 5 points each. 1) Explain bond risk and bond rating, and why they are important to investors. li) Explain the term s of interest rates and their value to in tructure and risk structure

Explanation / Answer

(i) Bond risk in simple terms refers to the risks linked with the investment in bonds. There are various constituents of bond risk which includes interest rate risk and credit risk. Bond risks can be effectively understood with the help of a suitable credit rating of the bonds. Bond rating is a measure of credit quality of the bond. The rating indicates the bond issuer's principal repayment and interest repayment capacity. The process of bond rating is undertaken by independent private rating agencies who undertake an independent evaluation of the financial strengths and backgrounds of the entities issuing the bonds and rates the bond accordingly. The bond rating helps investors in making informed decisions relating to their investments.

(ii) The term structure of interest rates relates to the relationship of interest rates/ bond yields with the different terms/maturity periods. The same is also referred to as the yield curve. The term structure of interest rates is a measure of the relative expectations of the market participants regarding the future changes in interest rates expected and their consequent assessment of monetary policy conditions. The increase in maturity of a bond results in an increase in yield. The position of the overall credit market position may be effectively analyzed by the investors with the help of the term structure of interest rates. The risk structure associated with the bonds refers to the default risk prevalent in the credit market. Risk structure relating to the bonds arise from factors such as liquidity, risk of default, tax matters, etc. A thorough understanding of the risk structure associated with a particular bond is crucial in understanding the relative risk components for the investor and plays a pivotal role in finding effective measures to mitigate the risks identified.

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