The Corporate Bond Credit Risk Premium

With the introduction of interest rate swaps in the early 1980s, lenders and investors were able to minimise their exposure to changes in interest rates, even for very long-dated commitments.¹¹Salomon Brothers brokered the first currency swap in 1981 between IBM and the World Bank, and interest rate swaps followed shortly thereafter. Arguably, the interest rate swap is one of the most useful innovations produced using financial engineering techniques. No longer must long-term investors worry about fluctuations in interest rates, they can mitigate that exposure by choosing to swap fixed rate for floating rate debt. Despite this success, only latterly have market participants begun to unravel the components that underlie the excess yields over those of credit benchmarks (eg, US Treasuries or swaps) required as compensation for investing in default-risky assets. Although the early work of Jones, Mason and Rosenfeld (1984) suggested that compensation for default accounted for only a small fraction of the credit spread, they attributed that result to a failure of their model of spreads