Churchill Corporation just issued bonds that will mature in 10 years. George Corporation just issued bonds that...

Churchill Corporation just issued bonds that will mature in 10 years. George Corporation just issued bonds that will mature in 12 years. Both bonds are standard coupon bonds and cannot be retired early. The two bonds are equally liquid. Which of the following statements is correct?

If the yield curve for Treasury securities is flat, Churchill's bond will have the same yield as George's bonds.

If the yield curve for Treasury securities is upward sloping, George's bonds will have a higher yield than Churchill's bonds.

If the two bonds have the same level of default risk, their yields will also be the same.

If the Treasury yield curve is upward sloping and Churchill has less default risk than George, then Churchill's bonds will have a lower yield.

If the Treasury yield curve is downward sloping, George's bonds will have a lower yield.

Solutions

Expert Solution

Longer maturity bonds generally carry a Maturity Risk premium and hence have higher yields

So, If the yield curve for Treasury securities is flat, Churchill's bond will have the same yield as George's bonds.- This statement may not be correct

If the yield curve for Treasury securities is upward sloping, George's bonds will have a higher yield than Churchill's bond- This is correct as not only the interest rates are higher for higher maturity, but because of Maturity risk premium George's bonds will have a higher yield than Churchill's bond

If the two bonds have the same level of default risk, their yields will also be the same.- This statement also may not hold as the maturity risk premium is there in George's bonds

If the Treasury yield curve is upward sloping and Churchill has less default risk than George, then Churchill's bonds will have a lower yield.- This statement again may not be correct as there is a maturity risk premium in George's bonds

If the Treasury yield curve is downward sloping, George's bonds will have a lower yield.- This statement again may not be correct as there is a maturity risk premium in George's bonds

So, only the 2nd statement is correct

jeff jeffy answered 1 year ago

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