CIC2007 Money And Banking

Lecturer: Dr. Shahrin Saaid Bin Shaharuddin

Occ 1 (Tuesday 9am - 12pm)
Presented by: Group 4
Group Members Matric Number (Old) Matric Number (New)

TAN CHIN KIET CIB190102 17206698/1

OOI YONG YIE CIB190086 17207161/1

PHANG JIE XIAN CIB190088 17204963/1

LIANG WAI LUN CIB190045 17207431/1

WONG JING NI CIB190121 17207547/1

Topic
Risk premiums on corporate bonds are usually anticyclical; that is,
they decrease during business cycle expansions and increase during
recessions. Why is this so?
Introduction

01
 Corporate bonds Treasury bonds

❖ Corporate bonds are bonds issued by ❖ Treasury bonds or government bonds are

companies. Investors who buy corporate government debt securities issued by the

bonds lend money to companies. government.

The main difference in terms of risk between corporate bonds and treasury bonds or government bonds is default risk.

OOI YONG YIE 17207161

 Corporate bonds

Default risk of corporate bonds are risk premiums on corporate bonds.

❖ Risk premiums are additional rewards to compensate investors for the additional risk

Risk Premiums they take.

Economic Boom Risk Premiums

Recessions Risk Premiums

OOI YONG YIE 17207161

The factors that cause
risk premiums on
corporate bonds

02
anticyclical
 Economic conditions
Economic boom Economic recession

❖ Few businesses go bankrupt ❖ Unemployment rate ↑

➢ Highest earnings potential
➢ Lack of workers
➢ Operating at full capacity because
inflation occurs
❖ Default risks ↑
➢ Due to increase of uncertainty in market
❖ Default risks ↓
➢ Increase company revenue and
❖ Consumer spending ↓
earnings ➢ Reduction in business sales & profit
❖ Investor confidence rises ↑
❖ Investor confidence ↓
➢ Willing to buy corporate bonds at a ➢ Offset risky investment with high risk
lower risk premium premium
❖ Risk premium ↓
❖ Risk premium ↑
➢ Borrowers are more likely to repay ➢ Attracts risk-takers to undertake risks
debt ➢ Generate higher ROI

LIANG WAI LUN 17207431 WONG JING NI 17207547

The Historical
Market Risk
Premium

03
The Flows of Risk Premium (1986-2022)
From 2008 to 2009:
- Great recession period
Indicates the risk premium increases - Global financial crisis
during recession and vice versa. - Increase in poverty rate

WONG JING NI 17207547

The Consequences of a
Cyclical Risk Premium
on Corporates Bonds

04
PHANG JIE XIAN 17204963
 Economic Collapse
❖ Economic Boom
➢ The companies make a lot of money
➢ Risk of investing in corporate bonds
is lower
➢ Provide confidence to investors
❖ If risk premium is cyclical:
➢ Investors will invest more and
indirectly cause inflation.
➢ Government will pursue tight
monetary policy by imposing high-
interest rates which cause fall in AD
and recession.
Reduced Investments in
Corporate Bonds
❖ Economic Recession
➢ Risk premium of corporate bonds will
become higher
➢ Offer investors a higher return with higher
risks
❖ If risk premium is cyclical:
➢ Investors face higher risks that generate a
lower return for them
➢ Businesses are not able to finance the
money
➢ Eventually lead to a vicious circle.
PHANG JIE XIAN 17204963
Conclusion

05
 Investors
● Confident with future
outlook Consequences of A
Economic Boom ● Willing to take corporate Cyclical Risk Premium on
bonds at ↓ risk premiums Corporates Bond
Businesses [What If…]
● Capable of generate profits
● More likely to repay debts,
& ↓ default risk Economic
1.
Collapse
Investors
● Less confident about future
Recession outlook, & less willing to spend
● Require ↑ risk premiums Reduced Investment
Businesses 2.
on Corporate Bonds
● Business activities slowdown
● ↑ default risk due to inability to
repay debt

TAN CHIN KIET 17206698/1

 References
Amadeo, K. (2021, October 26). What is an economic contraction? The Balance.
https://www.thebalance.com/economic-contraction-4067683

Education. (2013, June 6). In times of financial stress, what typically happens to the difference between interest rates on corporate bonds

and U.S. Treasury bonds? Federal Reserve Bank of San Francisco. Retrieved from

https://www.frbsf.org/education/publications/doctor-econ/2004/january/corporate-treasury-bonds-interest-rates-risk-spreads/
Hayes, A. (2021, December 13). Risk premium. Investopedia.
https://www.investopedia.com/terms/r/riskpremium.asp

Kagan, J. (October 19, 2020). Default Risk. Retrieved from

https://www.investopedia.com/terms/d/defaultrisk.asp

Rahoui, Mohamed M.. "Essays on the Equity Risk Premium" (2016). Doctor of Philosophy
(PhD), Dissertation, , Old Dominion University, DOI: 10.25777/x6cm-5e5

Tardi, C. (2020, December 30). Contraction definition. Investopedia.

https://www.investopedia.com/terms/c/contraction.asp
Thanks
!