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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

Just before the collapse of the subprime mortgage market in $2007$ , the most important credit-rating agencies rated mortgage-backed securities with Aaa and AAA ratings. Explain how it was possible that a few months into 2008, the same securities had the lowest possible ratings. Should we always trust credit-rating agencies?

Do you think that a U.S. Treasury bill will have a risk premium that is higher than, lower than, or the same as that of a similar security (in terms of maturity and liquidity) issued by the government of Colombia?

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

If the income tax exemption on municipal bonds were abolished, what would happen to the interest rates on these bonds? What effect would the change have on interest rates on U.S. Treasury securities?

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Go to http://www.federalreserve.gov/releases/h15 (historical data), and find the following three interest rate listings for AAA- and Baa-rated bonds: the most current listing; the listing for January 5, 2018; and the listings for June 1, 2008, and June 1, 2007. Prepare a http://www.federalreserve.gov/Releases/h15/update/ The Federal Reserve reports the yields on different-maturity U.S. Treasury bonds. graph that shows the interest rate information for these bonds over these three time periods (see Figure 1 for an example). Are the risk premiums stable, or do they change over time?

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