Question

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

Security	Yield ​(%)
Treasury	3.093.09
AAA corporate	3.153.15
BBB corporate	4.204.20
B corporate	4.864.86

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.

One year yield on AAA rated bond = 3.15%

Price of AAA rated zero coupon bond = $100 / (1 + 3.15%)

= $96.95

Price of AAA rated zero coupon bond is $96.95.

Price as percentage of Par = $96.95 / $100

= 96.95%

Price of AAA rated zero coupon bond as percentage of Par is 96.95%.

b.

Credit Spread of AAA rated bond = AAA rated corporated bond yield - Treasury bond yield

= 3.15% - 3.09%

= 0.06%

Credit Spread of AAA rated bond is 0.06%.

c.

Credit Spread of B rated bond = B rated corporated bond yield - Treasury bond yield

= 4.20% - 3.09%

= 1.11%

Credit Spread of Brated bond is 1.11%.

d.

Bond rating represents risk levelf o bond. AAA rated corporated bond is considered as lowest risky and B rated bond has higher level of risk. So, as risk increase, the required rate of return (yield) on bond also increase. So, cedit spread with B rated bond is higher than credit spread of AAA rated bond.