EECS 1541 Lecture Notes - Lecture 31: Bond Market, Risk Premium, Credit Risk
23 Jun 2018
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EECS 1541 Lecture 31 Notes
Introduction
Bond market
The yield that borrowers must pay (and that investors will receive) on a newly issued
bond varies among countries because of differences in the demand and supply of funds
available in the bond market in a given country.
The yield of a bond issue by a corporation is equal to the risk-free interest rate in that
country plus a risk premium that reflects the credit risk of that corporation.
EXAMPLE
In developed countries, there are many institutional and individual investors who are
willing to invest long-term funds in bonds.
Consequently, governments and many corporations in these countries can easily obtain
long-term funds by issuing bonds, and the yield that they pay on the bonds is relatively
low.
The yields on bonds may be lower in developed countries, such as Japan, where the
supply of long-term funds provided by institutional investors is high.
In developing countries, there are few investors with a large amount of long-term funds
available.
Those investors in developing countries who could afford to invest long-term funds
locally may be unwilling to do so for fear that the home country’s prospective borrowers
will default on the bonds.
Investors may also be unwilling to tie up their funds over the long term because they
fear a loss in purchasing power due to high inflation.
For these reasons, any borrowers in developing countries that want to issue bonds will
almost always have to pay a relatively high yield in order to attract investors.
Multinational corporations can obtain long-term debt by issuing bonds in their local
markets, and they can also access long-term funds in foreign markets.
An MNC may choose to issue bonds in the international bond markets for three reasons.
