Hend Abuenein
Active Member
Hi David,
In your T6 notes page 97, there's a 3D chart that plots relationship between credit spread, time to maturity, and interest rates.
I can see that the widening in CS only took place at the region of much deeper increase in T happened. But chart shows that CS is not affected by interest rate increase.
1- If T is held constant, what is interest rate's effect on CS?
2- Schweser's note's explanation on this is a bit confusing:
Why assume that a firm's risk of default is solely dependent on the firm's expected value?
I understand that under Merton's model firm value predicts its repayment, but what they're saying is that if interest rate goes up, a firm will be more likely to repay its debts regardless of all else going on in the firm or the economy that could be reducing firm value.
Do you agree with this?
I feel like this points at Merton model's disadvantages of non realistic assumptions.
In your T6 notes page 97, there's a 3D chart that plots relationship between credit spread, time to maturity, and interest rates.
I can see that the widening in CS only took place at the region of much deeper increase in T happened. But chart shows that CS is not affected by interest rate increase.
1- If T is held constant, what is interest rate's effect on CS?
2- Schweser's note's explanation on this is a bit confusing:
If interest rates increase, the expected value of the firm will increase, which decreases risk of default, and this narrows CS.
Why assume that a firm's risk of default is solely dependent on the firm's expected value?
I understand that under Merton's model firm value predicts its repayment, but what they're saying is that if interest rate goes up, a firm will be more likely to repay its debts regardless of all else going on in the firm or the economy that could be reducing firm value.
Do you agree with this?
I feel like this points at Merton model's disadvantages of non realistic assumptions.