The purpose of this article is to explain the spread between spot rates on corporate and government bonds. We find that the spread can be explained in terms of three elements: (1) compensation for expected default of corporate bonds (2) compensation for state taxes since holders of corporate bonds pay state taxes while holders of government bonds do not, and (3) compensation for the additional systematic risk in corporate bond returns relative to government bond returns. The systematic nature of corporate bond return is shown by relating that part of the spread which is not due to expected default or taxes to a set of variables which have been shown to effect risk premiums in stock markets Empirical estimates of the size of each of these three components are provided in the paper. We stress the tax effects because it has been ignored in all previous studies of corporate bonds. 1

This paper analyzes the pricing of defaultable securities in rating based models where the default of more than one agent is involved. We extend the model of Duffie and Huang (1996) to a framework which explicitly takes into account the rating of each party. Although our method is by no means restricted to swap contracts we will use as our illustrative example a plain vanilla interest rate swap

: In this paper, we investigate the pricing of Japanese yen interest rate swaps during the period 1990-96. We obtain measures of the spreads of the swap rates over comparable Japanese Government Bonds #JGBs# for di#erent maturities and analyze the relationship between the swap spreads and credit risk variables. Our empirical results in the yen swap market indicate that: 1# the commonly-used assumption of lognormal default-free interest rates and swap spreads is strongly rejected by the data, 2# the term structure of swap spreads displays a humped-shape, and 3# the shocks in the yen swap spread are negatively correlated with the shocks in the comparable default-free spot rates, especially for longer maturities. Our analysis also indicates that yen swap spreads behaved very di#erently from the credit spreads on Japanese corporate bonds in the early nineties. In contrast to Japanese corporate bonds, we #nd that the yen swap spread is also signi#cantly related to proxies for the longter...

Swap spreads, the interest rate differentials between the fixed rates on fixed-for-floating swap contracts and the yields-to-maturity on maturity-matched government bonds, define a market for one of the most actively transacted securities in the global fixed-income arena. A large universe of fixed-income securities including corporate bonds and mortgaged-back securities use interest rate swap spreads as a key benchmark for pricing and hedging. Swap spreads have received renewed attention since the Fall of 1998 when their volatile movements contributed in a significant way to the financial turmoil that led the US Fed to cut short-term interest rates by 75 basis points. In this paper we present new insights on how to analyze term structure of interest swap spreads. Specifically, we focus on the determinants of swap spreads and show how quantities such as the spread of short-term LIBOR over GC-repo rates, the liquidity premium commended by government bonds, and the risk premium required for holding long-term bonds/swaps jointly affect term structures of swap spreads.

risk factors in the US and UK interest rate swap markets:

Common risk factors in the US and UK interest rate swap markets:

This note provides a review of derivatives, their prudent management, their risks and regulatory and accounting requirements. The note is intended to provide a broad framework and detailed review of management issues arising from the use of derivatives. A glossary and bibliography is included. Questions regarding the note can be addressed to me at my Yearbook address. The table of contents refers to chapters 5-9 which are not included on this document.

The changing shape of fixed income markets: a collection of studies by central bank economists Monetary and Economic Department October 2001The views expressed in the papers in this volume are those of the authors and do not necessarily reflect the views of the BIS or the central banks represented in the Study group on fixed income markets. Individual papers (or excerpts thereof) may be reproduced or translated with the authorisation of the authors concerned. Requests for copies of publications, or for additions/changes to the mailing list, should be sent to:

We wish to thank Rob Brown for many useful comments and the participants of the 9 th Conference on the

In recent years there have been a number of papers examining the pricing of corporate debt. These papers have varied from theoretical analysis of the pricing of risky debt using option pricing theory, to a simple reporting of the default experience of various categories of risky debt. The vast majority of the articles dealing with corporate spreads have examined yield differentials of interestpaying