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1、Chapter7TheRiskandTermStructureofInterestRatesLearningObjectivesUnderstand...LO1CreditriskandbondratingsLO2TheyieldcurverelatingbondmaturitiestoyieldsLO3HowyieldsanticipateandsignalthefutureOnOctober5,1998,WilliamMcDonough,presidentoftheFederalReserveBankofNewYork,declared“Ibelievethatwearei
2、nthemostseriousfinancialcrisissince1WorldWarII.”SinceAugust17,whentheRussiangovernmenthaddefaultedonsomeofitsbonds,deterioratinginvestorconfidencehadincreasedvolatilityinthefinancialmarkets.Bondmarketswerethehardesthit;aslendersre-evaluatedtherelativeriskofholdingdifferentbonds,somepricesplu
3、mmetedwhileotherssoared.Thissimulta-neousincreaseinsomeinterestratesanddeclineinothers—ariseinwhatarecalledinterest-ratespreads—wasaclearsigntoMr.McDonoughthatthesubstantialstressthefinancialmarketswereexperiencingcouldeasilyspreadtothewidereconomy,af-fectingeveryone.Changesinbondprices,andt
4、heassociatedchangesininterestrates,canhaveapro-nouncedeffectonborrowingcostscorporationsface.TheexperienceofFordandGen-eralMotors(GM),theAmericanautomobilemanufacturers,providesaninstructiveexample.Likevirtuallyeverylargecompany,thetwocarmakersborrowtomaintainandexpandtheirbusinesses.Andthea
5、mountsareverylarge.By2005,Ford’sbor-rowingexceeded$150billionwhileGM’swasnearlytwicethat.Thetwocompaniesproduceaboutone-thirdofthecarsandtrucksAmericansbuy.Andtheybuyquiteafew—nearly15millionin2012.Butforyearsbeforethefinancialcrisisthatbeganin2007,thefortunesofU.S.automakersweredeclining.Pl
6、ummetingsalesinthereces-sionof2007–2009triggeredmassivelossesthateventuallyledtothebankruptcyofGM.EvenbeforeGM’sfailure,theperceivedriskinessofFordandGM’sbondsledtoadeclineinthepriceinvestorswerewillingtopayforthem.Afallinbondpricesmeansanincreaseininterestratesandacorrespondingriseinthecost
7、theautocom-panieshavetopaytoborrow.1Mr.McDonough’sjobwastomonitorfinancialmarketdevelopmentsfortheFederalReserveSystem,todevisegovernmentreactiontosuchfinancialcrises,andtoformulatepoliciesthatpreventedcrises.Aswewillseeinourdiscussionofthestructur
