Just a brief note on corporate bonds.? When I was a corporate bond manager 2001-2003, I learned a lot about inverted curves.? It was a tough time.? But what kind of inversion am I talking about?

Ordinarily, when there is little doubt over the creditworthiness of a company, the amount of incremental yield over Treasuries (spread) rises with the length of the security.? This is normal, leaving aside times when the yield curve is flat or inverted, because usually, the risk of default rises with time with even the best securities, because the future is less certain than the present.

The second stage is an inverted spread curve for a given company, which given a positively sloped Treasury yield curve, might leave the corporate yield curve positively sloped, but less so than Treasuries.? This indicates moderate worry over the credit risk of the company in question.? (Note: during a time of credit stress, the Treasury curve is almost always positively sloped, as the Fed tends to loosen during times of credit stress.)

Next is an inverted yield curve, where short term yields are moderately higher than long term yields.? This indicates significant worry over the credit risk of the company.

Finally, there is an inverted dollar (price) curve for the company.? This is where default is viewed as a likelihood.? The prices of the longest-dated bonds reflect current estimated recovery levels after default.? Short-dated bonds may trade near par. (Par: usually $100, also usually the amount of principal remaining to be received.)

This is a qualitative/quantitative way of thinking about the corporate bond market during a time of credit stress.? What percentage of the market falls into each bucket?

• Not inverted
• Inverted spread curve
• Inverted yield curve
• Inverted dollar price curve
• In default

The more names in lower categories, the greater the degree of credit stress.? For companies with multiple issues of bonds, it is a simple way of characterizing the market, even in the absence of rating agencies.? (As a closing aside, equity implied volatility tends to rise as a company goes down the list.)

Wait, that’s not quite a close, and not an aside.? That is another way to lookat corporate bonds.? As the implied volatility of the equity gets higher, the more they migrate down the list.? Remember, leaving aside bank loans, usually only stable companies issue corporate debt.? As their prospects get less certain, implied volatility of the equity rises, and their debt moves down the list.