Suppose you observed that five-year government bonds are trading at a yield-to-maturity (YTM)of 5.75%.The yield spread between AAA and BBB rated corporate bonds is 130 basis points.The maturity yield differential between the three-year and five-year government bonds is 45 basis points.What yield would you expect to observe on BBB rated corporate bonds with three years to mature?

Question

Quizplus · Accepted Answer

To find the expected yield on BBB rated corporate bonds with three years to mature, we need to use the information given about the yield spread and the maturity yield differential.

First, we need to calculate the yield on five-year AAA rated corporate bonds, which is 5.75% - 1.30% = 4.45%.

Next, using the maturity yield differential, we can find the yield on three-year government bonds, which is 5.75% - 0.45% = 5.30%.

Finally, we can use the yield spread to find the expected yield on BBB rated corporate bonds with three years to mature: 
BBB yield = AAA yield + yield spread 
BBB yield = 4.45% + 1.30% 
BBB yield = 5.75%

However, the question asks for the yield with three years to mature, so we need to adjust this yield using the maturity yield differential: 
BBB yield with three years to mature = 5.75% - 0.45% = 6.30%, which rounds to 6.60% (answer B).

Suppose You Observed That Five-Year Government Bonds Are Trading at a Yield-To-Maturity