This study extends the literature on the pricing of low-grade bonds by examining the performance of low-grade bond funds. The findings reveal that over the long run low-grade bond fund returns are approximately equal to the returns provided by an index of high-grade bonds. The relative risks of high and low-grade bonds are more difficult to assess. Because of their shorter durations, low-grade bonds are less sensitive to movements in interest rates than high-grade bonds. On the other hand, low-grade bonds are much more sensitive to changes in stock prices than high-grade bonds. When adjusted for risk using a simple two-factor model, the returns on low-grade bond funds are not statistically different from the returns on high-grade bonds.
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