1. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 7 Risk Structure and Term Structure of Interest Rates

2. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-2 Default Risk Default risk is measured relative to risk-free U.S. Treasury bonds. Default-risk premium = bond yield - yield on a comparable default-risk-free bond. The risk premium reflects in part the bond rating.

3. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-3 Table 7.1 Reading the Ratings Provided by Moody’s and Standard & Poor’s

4. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-4 Figure 7.1 Determining Default Risk Premium in Yields

5. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-5 Figure 7.2 Long-Term and Short-Term Yields in the United States, 1960–2006

6. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-6 Figure 7.3 Effect on the Risk Premium of a Decrease in Liquidity

7. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-7 Figure 7.4 Effect on Risk Premium of an Increase in Information Costs

8. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-8 Figure 7.5 Effect of Differences in Tax Treatment on Yields

9. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-9 Table 7.2 Risk Structure of Interest Rates

10. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-10 Yield Curve Yield curve is a graph of U.S. Treasury debt instruments as a function of maturity. Yield curve generally slopes upward. Yields on Treasury securities of different maturities have typically moved together.

11. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-11 Table 7.3 Theories of the Term Structure

12. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-12 Figure 7.6 Using the Yield Curve to Predict Interest Rates: The Expectations Theory

13. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-13 Figure 7.7 Interpreting the Yield Curve