Tuesday, January 13, 2009

Determinants of Bond Yield

Corporate Bonds inherently contain certain risks that investors most know and be cautious about when choosing to invest in bonds. The following table contains the most common risks that are determinants on bond yields.

  • A taxability premium compensates for unfavorable tax status of certrain classes of bonds
  • An Interest Rate Risk Premium compensates for holding securities for the long-term when their prices are more sensitive to interest rate changes
  • An Inflation premium compensates investors for the known fact that prices rise in the future and decrease purchasing power
  • A Liquidity Premium compensates for holding securities that are difficult to convert to cash at their true value
  • The Default Risk Premium compensates for the possibility that the issuer is unable to meet the required interest or required principal payments.
A combination of all these premiums are determinants of bond yields

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