Issuers creditworthiness

Moreover, duration will be influenced by the floater s stmcture. In fact, the choice of the reference rate affects the duration depending on how much volatile the index is. The lower the frequency of couptm payments, the greater the price sensitivity between reset dates. Thus, while floating-rate notes have a lower price sensitivity to a change of the reference rate, fixed and floating-rate notes both have a price sensitivity to changes of credit spread reflecting the issuer s creditworthiness. A shift of the credit term structure will determine the decline of the bond s price. 

Perhaps this makes no economic sense, but here is an example that will make things clearer. Suppose you buy a bond with a 1,000 face value, with a 10-year maturity, and it pays you interest of 5 percent per year. In three years time, interest rates have risen, and the same bond issuer (or another issuer with the same creditworthiness) is now issuing bonds with an 8 percent... 

To assess credit risk, individual investors are made aware of the issuer s creditworthiness by agencies such as Standard Poor s, Moody s, Fitch, and other bond-rating firms. Often, to make an issue more attractive, an issuer— usually a company or a municipality—will seek the stellar reputation of an underwriter (Salomon Smith Barney, Merrill Lynch, etc.) and now, as additional strength, will include a layer of insurance in the deal—all to reassure investors that credit risk is minimal. 

Some issuers are more creditworthy than others. When a bond issue s price is high and the yield is low, it usually means that the company or municipality has no risk of default. U.S. Treasury securities are priced very high and have a low yield precisely because of the reputation of their issuer the U.S. government. 

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