Unit 3 · Level 2 · Bonds & the boring half
Who are you lending to?
Rate moves aren't a bond's only risk. There's also the question of whether the borrower pays at all. Lending to Germany is near-certain repayment at a modest yield. Lending to a solid company pays a bit more. Lending to a shaky company ('high yield' politely, 'junk' honestly) pays a lot more. Same rule as always: when a yield looks juicy, ask where it comes from. With bonds the answer is usually 'default risk'.
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What you get asked
Why do junk bonds offer much higher yields than government bonds?
The market isn't giving gifts. The fat coupon is compensation for defaults that WILL hit some of these borrowers. Yield is the price of risk, not free money.
Match each bond type to its profile
The yield ladder is a risk ladder wearing a nicer outfit. Agencies like Moody's and S&P publish the grades; BBB− and above counts as 'investment grade'.
The extra yield a bond pays over safe government bonds is called the credit ___.
Spreads widen when investors fear defaults and shrink in calm times, which makes them a live gauge of how nervous the market is about a borrower.
In a recession, junk bonds tend to behave like...
Recessions push weak borrowers toward default, so junk sells off alongside stocks. If you buy bonds to cushion stock crashes, junk quietly fails the job description.
A company's rating slides from BBB to BB. What just happened?
BBB is the last investment-grade rung; BB is junk territory. Some funds are only allowed to hold investment grade, so a downgrade can trigger forced selling. The boring half has its own drama. 🐜
The rest of this unit
The see-saw of yields and prices, and the year 'safe' fell double digits.