Question

The yield on a 10-year US Treasury bond is 2.5%. ABC Co. and XYZ Co. each issue a 10-year bond. ABC’s bond has a yield of 3.5%; while XYZ’s bond has a yield of 5%. Select the statement below that BEST describes this situation.

A. The credit spread of XYZ’s bond is 5%.

B. XYZ Co. should have greater maturity risk than ABC Co.

C. The credit spread of ABC’s bond is 3.5%.

D. The credit spread of ABC's bond is 1%; and XYZ Co. should have greater default risk than ABC Co.

E. XYZ Co. should have a higher credit rating than ABC Co.

Answer 1

Option D. The credit spread of ABC's bond is 1%; and XYZ Co. should have greater default risk than ABC Co.

because Credit spread ABC = yield of ABC - yield of US Treasury = 3.50% - 2.50% = 1%

and Both XYZ and ABC have same maturity but the yield if different which means there is not maturity risk difference between them but there is a default risk on XYZ which made them to offer higher yield

Option A is incorrect because credit spread of XYZ = yield of XYZ- yield of US Treasury = 5% - 2.50% = 2.50%

Option B is incorrect because Both XYZ and ABC have same maturity but the yield if different which means there is not maturity risk difference between them but there is a default risk on XYZ which made them to offer higher yield

Option C is incorrect because Credit spread ABC = yield of ABC - yield of US Treasury = 3.50% - 2.50% = 1%

Option E is incorrect because XYZ has lower credit rating than ABC Co