. Consider the following four debt securities, which are identical in every char
ID: 2666012 • Letter: #
Question
. Consider the following four debt securities, which are identical in every characteristic except as noted:W: A corporate bond rated AAA
X: A corporate bond rate BBB
Y: A corporate bond rated AAA with a shorter time to maturity than bonds W and X
Z: A corporate bond rated AAA with the same time to maturity as bond Y that trades in a more liquid market than bonds W, X, or Y.
List the bonds in the most likely order of the interest rates (yields to maturity) of the bonds from highest to lowest. Explain your work.
Explanation / Answer
x, w, y, z from highest yield to lowest yield. YTM is a function of risk and time to maturity. As time to maturity increases, the required yield must increase as well. As risk increases, the YTM must increase too. As Z has a short maturity, in a more liquid market, and is AAA rated, it will be the least risky, and thus have the lowest yield. y would be next highest, as it has a short maturity, but is in a less liquid environment, which means it must have a higher yield to compensate for liquidity issues. W is next highest because although it is AAA rated, it has a longer maturity than Z or Y. As such it must have a higher return to compensate the bond holders. X must have the highest as it is BBB rated and is the most risk of the bonds. with the same maturity as W
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