Potential buyers of ABC Corporation bonds are not concerned about ABC Corporation declaring bankruptcy. Potential buyers of XYZ Corporation bonds are concerned that XYZ Corporation may declare bankruptcy. Which of the following statements is correct?
A)Other things equal, the interest rate on XYZ Corporation bonds will be high relative to the interest rate on ABC Corporation bonds.
B)An ABC Corporation bond is a perpetuity, whereas an XYZ Corporation bond is not a perpetuity.
C)XYZ Corporation bonds carry more interest-rate risk than do ABC Corporation bonds.
D)All of the above are correct.

Question

Quizplus · Accepted Answer

The potential bankruptcy of XYZ Corporation makes its bonds riskier, which means that potential buyers will demand higher interest rates to compensate for the risk. As a result, other things being equal, the interest rate on XYZ bonds will be higher than on ABC bonds.

B and C are incorrect. Perpetuity refers to a bond with no maturity date, which is not related to bankruptcy risk. Interest rate risk refers to the risk that changing interest rates will affect the value of the bond, which does not depend on the bankruptcy risk.

Potential Buyers of ABC Corporation Bonds Are Not Concerned About