Corporate bond prices have interest-rate exposure and equity exposure. Why?

What will be an ideal response?

Corporate bond prices have interest-rate risk exposure because of an two risk factors: Treasury yield risk factor and credit spread risk factors. They have equity risk exposure due to the extent it can risks similar to equity as is particularly true when a bond's credit rating is low. More details are provided below.

Two risk factors impact the price performance of a corporate bond: sensitivity to interest rates and exposure to equity risk. How important each risk factor is depends on the credit risk associated with the issuer of the bond. It is reasonable to expect that for investment-grade corporate bonds the dominant risk factor is interest-rate risk. In contrast, the equity risk factor becomes increasingly more important for high-yield corporate bonds, particularly the lower a bond's credit rating. This is the reason investors refer to lower-grade high-yield corporate bonds as being equity-like securities. Moreover, with respect to the interest-rate risk factor, a corporate bond is exposed to two risk factors: Treasury yield risk factor and credit spread risk factor. One would expect that the lower the credit risk of a corporate bond, the more important will be the Treasury yield risk factor compared to the credit spread risk factor.

There are implication in computing the interest-rate sensitivity of a corporate bond based on exposure to both equity risk and credit spread risk factors. Analytically we can use the standard formula for duration where given the coupon rate, maturity, and yield, the modified duration can be calculated. However, the resulting modified duration can fall short as a useful measure to predict how the bond's price will change when interest rates change. Given that modified duration does not take into account the equity risk factor and how changes in the credit spread may change, the analytically derived modified duration may also not be very useful.