As a lifetime chicken raiser, I see this everyday: when there are limited amount "goodies", head of the flock - typically a big mean rooster - takes the first peck; then the aggressive pure-breed laying hens; follwed by the docile commercial layers; meat birds are at the bottom of the pecking order.
How is this related to finance? There are many ways to finance corporate and government spending. So think this in terms of pecking orders of capital structure:
How is this related to finance? There are many ways to finance corporate and government spending. So think this in terms of pecking orders of capital structure:
i Stocks (ie equities);
ii Preferred stocks;
iii Non-investment grade (junk) corporate bond; MBS backed by subprime mortgages;
iv Sovereign / emerging market bond;
ii Preferred stocks;
iii Non-investment grade (junk) corporate bond; MBS backed by subprime mortgages;
iv Sovereign / emerging market bond;
v Local government bond (munies);
vi Investment grade corporate bond and prime mortage backed securities;
vi Investment grade corporate bond and prime mortage backed securities;
vii Treasury bond.
The higher the level, the later you claim the payments from the underlying economy; the less safe is your payment; hence the higher the required return to attract buyers.
While the very top and the very bottom have negative return correlations, adjacent pairs tend to demonstrate positive correlation.
So strictly speaking there is no 100% pure bonds or 100% pure stocks. Instead it is a continuum. At the risk of beig politically incorrect, the separation is like defining people by their sexual orientation. No one is 100% straight.
We will talk about bond term structure in another day.
Just my 2c
The higher the level, the later you claim the payments from the underlying economy; the less safe is your payment; hence the higher the required return to attract buyers.
While the very top and the very bottom have negative return correlations, adjacent pairs tend to demonstrate positive correlation.
So strictly speaking there is no 100% pure bonds or 100% pure stocks. Instead it is a continuum. At the risk of beig politically incorrect, the separation is like defining people by their sexual orientation. No one is 100% straight.
We will talk about bond term structure in another day.
Just my 2c
