Question

An actively traded corporate bond will likely (a) have a large bid-ask spread. (b) be rated lower by Moody's. (c) pose a large risk for the dealer. (d) have a lower yield-to-maturity than a less liquid bond. (e) have a lower coupon rate.

Answer 1

(d) have a lower yield to maturity than a less liquid bond.

Step-by-step explanation:

Bonds refer to debt instruments whereby the issuer avails long term finance by agreeing to pay a fixed rate of coupon payments periodically and principal repayment upon maturity.

Actively traded bonds refer to those bonds which are popular among the investors and traded frequently and in high volume.

Since actively traded bonds are highly rated and have lower credit risk i.e lower risk of default, such bonds have a lower yield to maturity than a less liquid bond.

Yield to maturity represents a bondholders required rate of return which is based upon market rate of return on similarly priced bonds.

Thus, an investor would like to be compensated by a higher yield to maturity when he invests in a less liquid bond.

Conversely, when an investor invests in an active bond, which are more liquid, his required rate of return would be comparatively lower than on a less liquid bond.