Question

Your firm has a BBB-rated corporate bond with a yield to maturity of 11.3%. A U.S. Treasury security that makes payments on the same date as your bond has a yield to maturity of 9.8%. These yields are quoted as APRs with semiannual compounding. Both bonds pay semi-annual coupons at a rate of 10.7% and have five years to maturity. What is the credit spread on your BBB bond?

Answer 1

The credit spread on your firm's BBB-rated bond is calculated by subtracting the yield to maturity of the U.S. Treasury bond (9.8%) from the yield to maturity of the corporate bond (11.3%), resulting in a credit spread of 1.5%.

Step-by-step explanation:

The credit spread of a bond represents the additional yield an investor earns from a bond over a risk-free bond, which is typically a U.S. Treasury bond, to compensate for the additional risk of the corporate bond defaulting. In the case of your firm's BBB-rated corporate bond with a yield to maturity of 11.3% and a U.S. Treasury bond with a yield to maturity of 9.8%, both quoted with semiannual compounding, the credit spread can be calculated by subtracting the Treasury bond's yield from the corporate bond's yield.

The calculation for the credit spread would be:
11.3% (corporate bond yield) - 9.8% (Treasury bond yield) = 1.5% (credit spread).

This means the credit spread on your BBB bond is 1.5%.