ECO 205 Lecture Notes - Lecture 6: Credit Risk, Risk Premium, Liquidity Premium

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3 Mar 2020

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Chapter 6: the risk & term structure of interest rates. Preview: in this chapter, we examine the sources & causes of fluctuations in interest rates relative to one another & look at a number of theories that explain these fluctuations. Learning objectives: identify & explain three factors explaining the risk structure of interest rates, list & explain the three theories of why interest rates vary across maturities. Risk structure of interest rates: bonds with the same maturity have different interest rates due to, default risk, liquidity, tax considerations. Figure 2 response to an in default risk on corporate bonds. The global financial crisis & the baa treasury spread: starting in august 2007, the collapse of the subprime mortgage market led to large losses among financial institutions. As a consequence, many investors began to doubt the financial health of corporations with low credit ratings such as baa & even the reliability of the ratings themselves.