Question

Issuing Company                    Years to maturity                    Yield

1. General Motors                   10 years                                   6.3 percent

2. NC Dept of Education        15 years                                   3.8 percent

3. US Treasury Strip               20 years, 0 coupon                  2.3 percent

4. York County B&T              15 years                                   5.6 percent                       

5. US Treasury                        10 years                                   3.4 percent

6. US Treasury                        20 years, 3.5 coupon               2.6 percent

7. Apple                                  15 years                                   4.1 percent

Briefly explain why these bonds have different interest rates

Do not use the same answer twice.

1. Bond 1 and Bond 2?

2. Bond 2 and Bond 6?

3. Bond 5 and Bond 6?

4. Bond 3 and Bond 7?

5. Bond 4 and Bond 7?

Answer 1

Bond yields and risk are directly correlated. Higher a bond's risk, higher its yield, and lower a bond's risk, lower its yield. This is because bond investors demand higher returns (yields) for investing in bonds with higher risk. Conversely, bond investors accept lower yields on bonds with lower risk.

Bond 1 is a corporate bond whereas Bond 2 is a government agency bond. Government agency bonds generally have lower risk than corporate bonds because government agency bonds are issued by agencies of the government, which make them very low-risk. Hence, the yield on Bond 2 is lower than Bond 1.

Bond 2 is a government agency bond, whereas Bond 6 is directly issued by the US Treasury. Bond 6 has lower risk compared to Bond 2, and hence has a lower yield.

Bond 5 and Bond 6 are both US Treasury bonds. However, Bond 6 pays a coupon whereas Bond 5 does not. As the cash flows of Bond 6 are received earlier (in the form of coupon payments), Bond 6 has lower risk, and therefore a lower yield.

Bond 3 is a Treasury bond, whereas Bond 7 is a corporate bond. Bond 7 has higher risk, and therefore a higher yield.

Bond 4 is a municipal bond, whereas Bond 7 is a high-quality corporate bond. Municipal bonds are generally riskier than high-quality corporate bonds. Therefore Bond 4 has a higher yield.