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Corporate bonds: Out of whack with market risks

S&P’s study says bonds are overpriced; Study suggests premiums should rise

For corporate bonds, 2009 might have been the party, but 2010 is the hangover. According to Standard & Poor’s, investors in US corporate bonds are taking on too much risk relative to the premiums they earn, which are far in excess of the levels they took before the financial crisis. The market, credit and risk strategies group (MCRS) at S&P has developed a new model to measure the risk-to-price, or credit risk-adjusted yield of each corporate bond in the S&P Composite 1500 Index, which helps determine whether investors are being compensated through yield, the market and credit risk they’re assuming.

The higher the risk-to-price score, the better the securities are in compensating the holders of the debt in terms of their credit and price exposure. The MCRS group, headed by Mike Thompson in New York, breaks the several thousand corporate issuers into four groups, known as Quartile 1-4, where Quartile 1 offers the best yield for risk, and Quartile 4 offers the least.

"Investors were getting less
yield than they were in 2007,
yet the probability of default
was higher, and volatility
risk was also higher"

Mike Thompson, MCRS

"What is really interesting from these results is that investors were getting less yield than they were in 2007, yet the probability of default was higher, and volatility risk was also higher," says Thompson.

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