Question

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.

Answer 1

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.