The following table summarizes yields to maturity on several 1-year, zero-coupon securities:
Security |
Yield |
Treasury |
3.130% |
AAA Corporate |
4.039% |
BBB Corporate |
4.701% |
B Corporate |
5.662% |
a. What is the price (expressed as a percentage
of the face value) of a 1-year, zero-coupon corporate bond with
a AAA-rating and a face value of $1,000?
The price, expressed as a percentage of the face value, is …………. (Round to three decimal places.)
b. What is the credit spread on AAA-rated corporate bonds?
The credit spread on AAA-rated corporate bonds is ……….%. (Round to three decimal places.)
c. What is the credit spread on B-rated corporate bonds?
The credit spread on B-rated corporate bonds is ………..%. (Round to three decimal places.)
d. How does the credit spread change with the bond rating? Why? (Select the best choice below.)
A.The credit spread increases as the bond rating increases, because higher rated bonds are riskier.
B.The credit spread increases as the bond rating falls, because lower rated bonds are riskier.
C.The credit spread decreases as the bond rating falls, because lower rated bonds are riskier.
D.The credit spread decreases as the bond rating increases, because higher rated bonds are riskier.
Part a:
Z = $961.178
Hence, price as % of face value = $961.178/$1000 * 100 = 96.118%
Part b:
Credit Spread = Yield on bond - Treasury Rate
For a AAA bond, credit spread = 4.039% - 3.130% = 0.909%
Part c:
Credit Spread = Yield on bond - Treasury Rate
For a B bond, credit spread = 5.662% - 3.130% = 2.532%
Part d:
Correct option is B. The credit spread increases as the bond rating falls, because lower rated bonds are riskier.
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