Question

The difference between the required rate of return on a corporate bond and the yield on a corresponding treasury of the same maturity is called the

1) Yield to maturity
2) Spread
3) Inflation rate
4) Risk return relationship

Answer 1

The difference between the rate of return on a corporate bond and the yield on a corresponding Treasury bond is called the spread, which reflects the risk premium for the higher risk associated with corporate bonds.

Step-by-step explanation:

The difference between the required rate of return on a corporate bond and the yield on a corresponding Treasury bond of the same maturity is known as the spread. The required rate of return on a bond comprises several components, such as compensation for delaying consumption, an adjustment for inflation in the price level, and a risk premium reflecting the borrower's credit risk. This spread is larger for corporate bonds because these bonds are considered riskier than government Treasury bonds, thus they require a higher return to compensate for this increased risk.

Corporate bonds typically offer higher interest rates compared to Treasury bonds because they include a risk premium for the potential default risk associated with the issuing corporation. On the other hand, Treasury bonds, which are backed by the federal government, have lower rates as they are considered to have virtually no default risk. Figure 17.5 suggests that while corporate and Treasury bond rates tend to move in tandem, the yield spread between them reflects the differing levels of risk and expected return.