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ECON 351 (21)
Chapter 5

Chapter 5_Risk Structure and Term Structure of Interest Rate.docx

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Pennsylvania State University
ECON 351
Frank Sorokach

Chapter 5: Risk Structure and Term Structure of Interest Rate  How Bond Ratings work? - Abond's credit rating is measured by a grading system that starts with a rating ofAAAfor bonds least likely to default, all the way down to "D" for bonds that default. Junk bonds have a rating of BB or lower. - Bonds that have a high credit rating are known as investment-grade bonds. Bonds that are likely to default are called speculative or non-investment grade. - The price of your bonds will go down when their credit ratings are lowered but when a credit rating is raised; the price of your bond could go up.  Junk Bonds - Popular name for corporate bonds the rating agencies have given a lower than investment grade rating [for example, a rating of Ba or below from Moody’s]. Everything below BBB under Non-investment grade as well. It is also known as “FallenAngels” or Sub-Prime Bond - It will default but if you enough of these than it will have better returns. - Investors pulled more than $45 billion from stock mutual funds while adding more than $75 billion to their holdings of bond mutual. - Michael Milken, a bond salesman at the investment bank Drexel Burnham Lambert which first rose to prominence and then was forced into bankruptcy in February 1990 by its involvement in illegal activities in the junk bond market  Tax Treatment - Investors receive interest income in the form of coupon payment payments on bonds. - Investors must include these coupons in their income when paying their taxes. - Tax paid on coupons differs, depending on who issued the bond - It also varies depending on where the investor lives.  How the Tax treatment of Bonds Differs
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