Final answer:
Bond yields for Treasury and Corporate bonds differ mainly due to risk, with higher Corporate bond yields compensating for the increased risk of default. Factors like bond ratings, inflation, and maturity periods also affect yields.
Step-by-step explanation:
When plotting the yields on a grid for Treasury bonds, Corporate bonds rated AA, and those rated A, it's important to understand the differences in their interest rates. Typically, Treasury yields are lower than Corporate yields due to the perceived safety of government-backed securities.
Corporate bonds are issued by firms and are categorized based on their creditworthiness by rating agencies like Moody's. Bonds rated AAA are seen as safer and, therefore, pay lower interest rates compared to those with AA or A ratings. However, all corporate bonds usually offer higher yields than Treasury bonds due to the higher risk of default. Yields can vary based on multiple factors:
- Treasury yields compared to Corporate yields are influenced by the risk premium demanded by investors for taking on additional risk.
- Changes in bond ratings over time can result from adjustments in a corporation's financial health, affecting yields.
- The impact of inflation on yields causes rates to increase to compensate for the eroding value of interest payments over time.
- Maturity periods can affect yields as well, with longer-term bonds typically offering higher returns to compensate for time-related risks such as interest rate changes and inflation.