Question

Listed below are data that pertain to the corporate bond market.

(Note: Each "period" below covers a span of 6? months.)(Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.)

	Period 1	Period 2	Period 3	Period 4
Average yield on 10 high-grade corporate bonds	5.26 %5.26%	5.65 %5.65%	5.07 %5.07%	??
Yield on the Dow Jones average of 40 corporate bonds	6.51 %6.51%	??	5.97 %5.97%	4.86 %4.86%
Yield spread (in basis points)	??	154154	??	2828
Confidence index

a.Compute the confidence index for each of the 4 periods listed above.

b.Assume the latest confidence index? (for period 0, in effect) amounts to

86.83 %86.83%?,

while the yield spread between? high- and? average-grade corporate bonds is

8585

basis points. Based on your calculations, what's happening to bond yield spreads and the confidence index over the period of time covered in the problem? (i.e., from period 0 through period? 4)?

c.??Based on the confidence index measures you? computed, what would be your overall assessment of the stock? market? In which one or more of the periods? (1 through? 4) is the confidence index? bullish? In which? one(s) is it? bearish?

 

Answer 1

Answer a:

Confidence index= Average yield on 10 high-grade corporate bonds / Average yield on 40 intermediate-grade bonds

Yield on Dow Jones average of 40 corporate bonds = Average yield on 10 high-grade corporate bonds + (Yield spread / 100)

Average yield on 10 high-grade corporate bonds = Yield on Dow Jones average of 40 corporate bonds - (Yield spread / 100)

Period 1:

Confidence index for period 1 = 5.26 % / 6.51% = 80.80%

Period 2:

Yield on Dow Jones average of 40 corporate bonds = 5.65% + (154/100) % = 7.19%

Confidence index for period 2 = 5.65% / 7.19% = 78.58%

Period 3:

Confidence index for period 3 = 5.07% / 5.97% = 84.92%

Period 4:

Average yield on 10 high-grade corporate bonds = 4.86% - (28/100) % = 4.58%

Confidence index for period 2 = 4.58% / 4.86% = 94.24%

Answer b:

For Period 0:

Assume the latest confidence index amounts to = 86.83%

while the yield spread between high- and average-grade corporate bonds is = 85

Hence,

86.83%= Average yield on 10 high-grade corporate bonds / Average yield on 40 intermediate-grade bonds

Let us assume Average yield on 10 high-grade corporate bonds = X%

Hence:

86.83%= X% / [X % + ( 85÷100)]

=> X % = (X% + 0.85) * 86.83% = 86.83% * X% + 0.7381

=> X % (1- 86.83%) = 0.7381

=> X% = 0.7381 / 0.1317 = 5.60%

Hence,

Yield on Dow Jones average of 40 corporate bonds= 5.60%+ (85÷100) = 6.45%

For Period 1:

Yield spread = (6.51 - 5.26) * 100 = 125

For Period 3:

Yield spread = (5.97 - 5.07) * 100 = 90

Hence for Period 0 to Period 4:

From above data, we observe that for the period 0 to period 2 yield spread goes up while confidence index goes down. From period 2 to period 4 yield spread goes down while confidence index goes up.

From this behavior, we observe that when bond yield spread tends to increase the confidence index tend to decrease.

Answer c:

The overall market is volatile.

The most bullish period is period 4, while the most bearish period is period 2.