Question

The following table summarizes the yields to maturity on several one-year, zero coupon securities:Security yieldTreasury 3.15AAA corporate 3.23BBB corporate 4.27B corporate 4.94A. 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 coporate bonds?D. How does this credit spread change with the bond rating? why?(round to nearest cent)

Answer 1

a. 96.87%

b. 0.08%

c. 1.79%

d. Please read the explanation below.

Step-by-step explanation:

a. Number of compounding period (t) = 1

Yield to maturity = 3.23%

Assume the face value of Zero compund bond is 1.000.

Calculate the price

Price = Face Value / (1+YTM)^t

= 1.000/(1+0.323)^1

=968.71

Price expressed as a % to face value = Price / Face Value * 100 = 96.87%

b. Credit spread = Yield of AAA - Yield of treasury bond = 4.94% - 3.15%= 0.08%

c. Credit spread = Yield of B - Yield of treasury bond

= 4-94% - 3.15%

=1.79%

D. The credit rating a bond changes with its corresponding change in the credit risk. That means higher the risk, lower will be the rating of the bond and vice versa.

The investors demand for higher return on risky bonds for undertaking additional risk. Therefore, the credit spread widens as the bonds rating falls with an increase in the risk.