Bonds X and Y are very similar: they have the same face value, the same coupon...

Bonds X and Y are very similar: they have the same face value, the same coupon rate, the same maturity, and both make semi-annual payments. Bond X has a credit-rating of AA. Bond Y has a credit rating of BB. Which bond will have the higher yield to maturity? Why?

Solutions

Expert Solution

Bond Y with credit rating BB will have higher yield to maturity.

There exists an inverse relationship between credit rating of bond and its yield to maturity. This means

When credit ratings are high, yield to maturity will be low.
When credit ratings are low, yield to maturity will be high.

To understand this we need to acknowledge that risk and return goes hand in hand. Which means an investor willing to take more risk will be rewarded with higher returns and vice-versa.

Similarly bonds with higher credit ratings means that there is a low risk of default in such bonds and thus offer lower yields. Bonds with low credit ratings are risky and thus the investor will want more yield for making investment in such bonds. Thus bonds with lower credit rating will involve greater risk and thus it will have higher yield to maturity.

Bond with credit rating of AA will have lower risk.

Bond with credit rating of BB will have higher risk.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

The face value of a bond is $1,000. The bonds have a 4.25% coupon rate paid...

The face value of a bond is $1,000. The bonds have a 4.25% coupon rate paid semi-annually and mature in six years. What is the yield to maturity (express at an annual rate) for the bonds if an investor buys them at the $875 market price?

You have bought 100 bonds with a face value of $1,000, an annual coupon rate of...

You have bought 100 bonds with a face value of $1,000, an annual coupon rate of 6 percent, a yield to maturity of 8 percent, and 10 years to maturity. Now you are concerned that rates will rise and the bond value will, therefore, drop. You want to take a short (sell) position on another bond with face value of $1,000, an annual coupon rate of 5 percent and a yield to maturity of 7 percent, and 8 years to...

The bonds of Tiger Paw, Inc. carry an 8% annual coupon, have a $1,000 face value,...

The bonds of Tiger Paw, Inc. carry an 8% annual coupon, have a $1,000 face value, and mature in 6 years. Market rate is 5%. What is the market value of Tiger’s bonds? (bond valuation)?

Three coupon bonds with a 10% coupon rate all just sell for their face value of...

Three coupon bonds with a 10% coupon rate all just sell for their face value of $1,000. The three bonds will mature in one, two, and five years, respectively. Interest rates on all these bonds are 10% when they are bought, but decline to 5% after they are purchased. Calculate the one-year rates of return on these bonds. What are the initial current yields and the one-year rates of capital gain on these bonds? Which of the three bonds would...

A bond has a par value of R500 and a coupon rate of 16%. Similar bonds...

A bond has a par value of R500 and a coupon rate of 16%. Similar bonds have a required return of 18% annually. Interest is paid semi-annually. An investment into these bonds has 13 years to maturity. Calculate how much An investor can pay on these bonds today.

Borland, Inc. issues 25-year semi-annual bonds that have a face value of $1,000 and a coupon...

Borland, Inc. issues 25-year semi-annual bonds that have a face value of $1,000 and a coupon rate of 7.5%. The current market price for the bonds is $950.00. If your required rate of return is 8.5%, what is the value of one of these bonds to you? (Your answer should be with +/- $0.02 of the following answers.) Group of answer choices $977.95 $978.09 $950 $897.03

Hue company had $300,000,000 of debt outstanding at Face Value. The bonds have annual 2% coupon...

Hue company had $300,000,000 of debt outstanding at Face Value. The bonds have annual 2% coupon payments and a remaining life of 8 years to maturity. The bonds just got re-rated and the market determined yield to maturity changed from 5% to 3%. By what amount did the market value of the bond change?

ABC company had $300,000,000 of debt outstanding at Face Value. The bonds have annual 2% coupon...

ABC company had $300,000,000 of debt outstanding at Face Value. The bonds have annual 2% coupon payments and a remaining life of 8 years to maturity. The bonds just got re-rated and the market determined yield to maturity changed from 5% to 3%. By what amount did the market value of the bond change? a. $51,168,915 recognized decrease in bond value b. $51,168,915 recognized increase in bond value c. $37,109,838 recognized decrease in bond value d. $37,109,838 recognized increase in...

ABC company had $300,000,000 of debt outstanding at Face Value. The bonds have annual 2% coupon...

ABC company had $300,000,000 of debt outstanding at Face Value. The bonds have annual 2% coupon payments and a remaining life of 8 years to maturity. The bonds just got re-rated and the market determined yield to maturity changed from 5% to 3%. By what amount did the market value of the bond change? a. $51,168,915 recognized decrease in bond value b. $51,168,915 recognized increase in bond value c. $37,109,838 recognized increase in bond value d. $37,109,838 recognized decrease in...

PowerTap Utilities is planning to issue bonds with a face value of $1,500,000 and a coupon...

PowerTap Utilities is planning to issue bonds with a face value of $1,500,000 and a coupon rate of 10 percent. The bonds mature in 10 years and pay interest semiannually every June 30 and December 31. All of the bonds were sold on January 1 of this year. PowerTap uses the effective-interest amortization method. Assume an annual market rate of interest of 12 percent. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use the appropriate...

Subjects