Question

Q19)

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

Security	Yield ​(%)
Treasury	3.13
AAA corporate	3.22
BBB corporate	4.28
B corporate	4.96

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) AAA Rate Corporate Bond Yield = 3.22 % and Face Value = $ 1000 (assumed)

Therefore, Price = 1000 / (1.0322) = $ 968.8045

Hence, price as a % of Face Value will be ~ 96.68 %

(b) Credit Spread for AAA rated corporate bond = AAA Rated Bond Yield - Treasury Bond Yield = 3.22 - 3.13 = 0.09 %

(c) Credit Spread for B rated corporate bond = B Rated Bond Yield - Treasury Bond Yield = 4.96 - 3.13 = 1.83 %

(d) As is observable, as the bond rating goes down, the credit spread increases. This happens because lower rated bonds have greater credit risk, thereby requiring higher yields and greater credit spreads.