The spread between riskless and risky bonds. Immediately after the British voted for Brexit, two major credit
Question:
The spread between riskless and risky bonds. Immediately after the British voted for Brexit, two major credit rating agencies, Standard \& Poor's and Fitch, downgraded the U.K.'s sovereign rating by two notches, from AAA to \(A A\).
The spreads fluctuate between riskless rates on 5-year and 10-year U.K. Government bonds versus the 10-year AAA and BBB corporate bonds. Go to the Web site of the Bank of England (http:// www.bankofengland.co.uk/) to extract the government bond yields.
a. What are the main requirements for a bond to be risk free? Does the downgrade of the U.K. sovereign rating imply that the U.K. government bonds would become riskier? Do you expect further credit rating downgrades for U.K. corporations? If so, what is most likely sector which you think is the most likely to be downgraded? Why?
b. Compare the yields and spreads of high-grade government and corporate bonds from any of the highly cited Web sites such as http://www.bloomberg.com/ - namely the U.K. Sovereign Bond Index (BRIT: IND) with the GBP High Yield Corporate Bond Index (BGBH: IND). Fill in the table below quoting the latest available yields with the yields on 20 June 2016 (just after the Brexit vote).
c. Explain and interpret the causes of the changes in the spreads and the in the risk premium for both categories of bonds since the Brexit vote.
Step by Step Answer:
