Despite the difference in methodology between the Cornell and Green study and the other two studies, all three studies conclude that low-grade bond
returns and resulting holding-period risk premiums are consistent with their systematic risk and that low-grade bonds
are fairly priced relative to high-grade debt.
Finally, stochastic dominance model is applied to show that small stock returns dominant low-grade bond
Many fund managers assert that low-grade bond
returns are more sensitive to changes in economic activity than to changes in interest rates.
1994, "Unravelling the Low-Grade Bond
Risk/Reward Puzzle," Financial Analysts Journal (July/August), 32-42.
New merger proposals dropped off noticeably during the first part of 1990 as a consequence of the virtual unavailability of funds for new financing in the low-grade bond
market; the more cautious attitude of commercial banks, both domestic and foreign; and the weakening in the market for asset sales.
Cornell and Green (1991) rely on the returns for low-grade bond
funds to estimate the risks and returns for these bonds.
Shane (1994) writes, "A low-grade bond
can be viewed as a hybrid security consisting of a government bond and a claim on the issuing firm's equity.
At year-end 1998, medium- to low-grade bond
and unaffiliated stocks represented 154% of total adjusted capital.
Salter suggested a mix of 2% low-grade bonds
, 30% large-cap, 24% mid-cap, 20% small-cap, and 24% international stocks, the latter preferably within a managed fund.
Over the relevant time period, the Fund's net asset value (NAV) declined by 45 percent as a result of, among other things, the Fund's overexposure to low-grade bonds
, unrated bonds, high-risk securities and the California real estate market.
They conclude that low-grade bonds
display characteristics of both small stocks and high-grade bonds.
The company's ratio of risk assets (the sum of low-grade bonds
, mortgages, real estate, and equities) to total adjusted capital of 30.