Part I - Risk Premium (Part 1)

The Federal Reserve Bank of St. Louis publishes a weekly index of financial stress (FRED code: STLFSI) that summarizes strains in financial markets, including liquidity problems. For the period beginning in 1994, plot this index and, as a second line, the difference between the Baa corporate bond yield (FRED code: WBAA) and the 10-year U.S. Treasury bond yield (FRED code: WGS10YR).

1. What does the difference between Baa corporate bond yields and 10-year U.S. Treasury bond yields measure?
2. What do you expect to happen to the spread in the two interest rates during periods of financial stress
3. Does the index STLFSI provide an early warning of stress?

Part 2 - Risk Premium (Part 2)

How did the Great Depression (19291933) and the Great Recession of 20072009 affect expectations of corporate default? To investigate, construct for each of those periods a separate plot of the corporate bond yield spread. For the Depression period, plot from 1930 to 1933 the difference between the Baa corporate bond yield (FRED code: M13036USM193NNBR) and the long-term government bond yield (FRED code: M1333AUSM156NNBR). For the Great Recession, plot from 2007 to 2009 the difference between the Baa yield (FRED code: BAA) and the 10-year Treasury bond yield (FRED code: GS10).

1. How did the spread different between the two periods?
2. In which period would you expect corporate bond defaults to be greater? iii Provide a link to your graph.

Part 3 - Flight to Quality

Measure the flight to quality by graphing the relationship between the 10-year constant maturity (U.S. bond) and Moodys Baa Corporate Bond Yield.

1. How did the risk premium change during the Great Recession? Pandemic?
2. What are the implications for small businesses, households?
3. How has the flight to quality been different during the coronavirus pandemic? Why do you think this is? What can you learn about today?
4. Provide a link to your graph.