Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72%
A = 9.64%
AAA = 8.72%
BBB = 10.18%
What most probably caused the differences in rates among these issues?

Question

Quizplus · Accepted Answer

The most probable cause of the differences in rates among these issues is default risk differences. The higher the default risk, the higher the required return on the bond to compensate investors. The ratings (A, AAA, BBB) reflect the perceived creditworthiness of the issuer, and the interest rates increase as the ratings get lower because the default risk is higher. The difference in rates can't be attributed to real risk-free rate differences or inflation differences because they are not given to be different for each bond. Maturity risk differences do not explain the differences among these bonds because they all have the same maturity of 20 years.

Assume That Interest Rates on 20-Year Treasury and Corporate Bonds