Question

The following table summarizes the yields to maturity on several​ one-year, zero-coupon​ securities:

Treasury 3.08%

AAA corporate 3.22%

BBB corporate 4.19%

B corporate 4.89%

a. What is the price​ (expressed as a percentage of the face​ value) of a​ one-year, zero-coupon corporate bond with a AAA​ rating?

b. What is the credit spread on​ AAA-rated corporate​ bonds?

c. What is the credit spread on​ B-rated corporate​ bonds?

d. How does the credit spread change with the bond​ rating? Why?

Answer 1

a. YTM of AAA rating =3.08%
Price of corporate bond =Par Value/(1+Rate)^n =1000/(1+3.22%) =968.80
Percentage =96.88%

b. Credit Spread on AAA-Rated corporate bond =AAA YTM bond -Treasury Rate =3.22%-3.08% =0.14%

c. Credit spread on B-Rated corporate bond =V YTM bond -Treasury Rate =4.89%-3.08% =1.81%

d. Credit spread decreases with increase in rating. Higher the rating lower is the default probability of the bond, lower the rating higher is the probability of default. More is the risk in the firm.