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An Introduction to Derivative Securities, Financial Markets, and Risk ManagementAdvanced Financial Risk Management, 2nd ed.

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We last analyzed AT&T Inc. (T) on December 16, 2013 using bond price data from December 13. AT&T Inc. is attractive to many analysts and investors because the current dividend yield is more than 5 percent. At the same time, AT&T Inc. is dealing with on-going upheavals in the telecommunications industry and is surrounded by rivals who are both aggressive and highly risky from a credit risk perspective.

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PepsiCo, Inc. (PEP) is an iconic name among U.S. consumer products companies. So far, in this series of notes, we have often seen the bonds of iconic names over-priced to such a degree that the reward to risk ratio for such names was far below average. Nonetheless, in today’s analysis, we make no assumptions about such things at this point. Instead, we let the bond market facts lead us to the appropriate conclusions. Today’s study incorporates PepsiCo, Inc. bond price data as of April 17, 2014 to get an institutional, bond market view of the company. We analyze the potential risk and return to bondholders of PepsiCo, Inc. using 87 trades on 15 bond issues and a trading volume of $41.9 million in today’s analysis. We also use bond market data to calculate the credit-adjusted dividend ratio for PepsiCo, Inc.

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We last reviewed the best value bond trades in the 1 to 5 year maturity spectrum on March 18. Today, we update that analysis using trade data from April 17, a relatively light pre-holiday trading day. On April 17 in the U.S. bond market, there were 19,628 bond trades in 3,973 non-call fixed rate corporate bond issues representing $5,317,782,257 in notional principal. Which 20 trades were the best trades of the day, and how do we decide the answer to that question? Today, we answer those questions for bonds with maturities of 1 to 5 years at the request of many investors. The answers to these questions are particularly important given the well-known inability of legacy credit ratings to match the accuracy of quantitative methods used in this series of notes. We ignore legacy ratings in this analysis for that reason.

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Projected one month Treasury bill rates rose by more than 0.25% this week in the 2017 to 2018 period, while T-bill rates in 2021 and beyond declined slightly. Forward 1 month T-bill rates are now projected to peak in the second quarter of 2021 at 3.90%, down from a 3.92% 2021 fourth quarter peak projected last week. This is the fourth consecutive implied peak in one month bill rates, something not seen for a few years. The impact of the peak can be seen in the three dimensional graph of Treasury yield movements (below) and Treasury and mortgage forward rates. The forecast shows projected 10 year U.S. Treasury yields rising steadily to 4.051% in 2024. Projected 15 year fixed rate mortgage yields in 2024 show a rise to 5.773%, down 0.13% from last week.

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Traditional analysis of common stocks uses a wide array of financial ratios to measure value. One of the ratios most often discussed is the dividend yield on a stock. In this note we explain why the dividend yield ignores credit risk. We show that a credit-adjusted dividend yield provides much greater insight to the likely dividend return to common stock investors, as we explained in a recent note on General Electric Company (GE). Using the example of Comcast Corporation (CMCSA), we show that the long-term credit-adjusted dividend ratio is 1.61%, not the commonly quoted 1.86%. The credit-adjusted dividend yield allows investors to compare dividend yields on companies of wildly varying credit risk on an apples to apples basis.

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