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Chapter 6: Q.10 (page 188)

During 2008, the difference in yield (the yield spread) between three-month AA-rated financial commercial paper and three-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to zero, spiking to over a full percentage point at its peak in October 2008. What explains this sudden increase?

Short Answer

Expert verified

As a result, demand for financial commercial papers has decreased in comparison to non-financial commercial papers. As a result, it shows that financial company investments are risky.

Step by step solution

01

Introduction

A bond is a fixed amount of income investment that is given to an entity for a specific length of time.

02

To determine

The cause of the sudden increases.

03

Explanation

Financial companies suffered greatly as a result of the global financial crises, which produced uncertainty about the financial system. At the time, even the sound banks and financial system were not trusted.

As a result, demand for financial commercial papers has decreased in comparison to non-financial commercial papers. As a result, it shows that financial company investments are risky.

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Most popular questions from this chapter

鈥淎ccording to the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond if interest rates on one-year bonds are expected to be the same in both years.鈥� Is this statement true, false, or uncertain?

If the yield curve suddenly became steeper, how would you revise your predictions of interest rates in the future?

In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis. Using bond market graphs, compare the effects on the risk premium between U.S. Treasury debt and comparable-maturity Greek debt.

Predict what would happen to the risk premiums of municipal bonds if the federal government guarantees today that it will pay creditors if municipal governments default on their payments. Do you think that it will then make sense for municipal bonds to be exempt from income taxes?

If expectations of future short-term interest rates suddenly fell, what would happen to the slope of the yield curve?
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