Question

A bond has the following interest rate elements used. r= r* + IP. What type of bond is it? and why?

1-US Government Short-Term

2-US Government Long-Term

3-AAA Corporate

4-AA Corporate

Answer 1

It is AA corporate bond in which r=r*+ip is used .

The whole formula is r=r*+IP+DRP+LP+MRP where r= nominal rate

r*= real risk rate free

IP = inflation premium

DRP= default risk premium

MRP = maturity risk premium

LP= liquidity premium

An investment grade is a rating that signifies a municipal or corporate bond presents a relatively low risk of default. AA is considered to be high grade for a bond but not quite a prime grade while AAA rating mean that a bond has virtually no chance of default, AAA rating means mhat there is a low chance of a default.Corporate bond generally has the higher risk of default. This risk depends on the particular corporation issuing the bond,the current market conditions and the govt to which the bond issuer is being compared and the rating of the company. The level of yields generally in a bond market as expressed by govt bond yields may change and this being about changes in the market value of fixed coupon bond so that their yield to maturity adjusts to newly appropriate level.

An investment grade rating signals that a corporate or municipal bond has a relatively low risk of default. Different bond rating agencies have different rating symbols to signify investment grade bonds.

AArating to companies it considers to be the least likely to default.

The real risk free rate takes the risk free rate and incorporate inflation risk into the equation. Inflation is too often overlooked when assessing investment return but when high it can quickly erase actual wealth gains.

Corporate bond are considered to have a higher risk than govt bond which is why interest rate are almost always higher on corporate bond even for a companies with top flight credit quality.

AA corporate bond has 4.33% for a 20 yr .when the interest rate rise the market value of bond fall. if u have a bond with a coupon of 3% and the cash rate increases from 3% to 4%. Eg- the coupon rate on the bond is less attractive to investors so that that will be willing to pay less for it.

AA bond has the higher interest rate than U.S. They have the higher growth potential. They are less vulnerable too inflation and interest rate increases than government bonds due to generally shorter period of redemption.