Reading 63: Understanding Yield Spreads LOS h习题精选 face, 2010, corporate, relative, average

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LOS h: Explain how the liquidity or issue-size of a bond affects its yield spread relative to risk-free securities and relative to other securities.

Consider three corporate bonds that are identical in all respects except as noted:

• Bond F has $100 million face value outstanding. On average, 200 bonds trade per day.
• Bond G has $300 million face value outstanding. On average, 200 bonds trade per day.
• Bond H has $100 million face value outstanding. On average, 500 bonds trade per day.

Will the yield spreads to Treasuries of Bond G and Bond H be higher or lower than the yield spread to Treasuries of Bond F?

A) Higher for both.

B) Higher for one only.

C) Lower for both.

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Liquidity is attractive to investors, so they will pay a higher price (demand a lower yield) for a more liquid bond than for an identical bond that is less liquid. Bond G is more liquid than Bond F because of its greater size. Bond H is more liquid than Bond F because it trades in greater volume. Therefore both Bond G and Bond H will tend to have lower yield spreads to Treasuries than Bond F.

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Relative to a bond sold as part of a large issue, an otherwise equivalent bond that is sold as part of a smaller issue will be sold for a:

A) lower price and have a lower yield to maturity.

B) higher price and have a lower yield to maturity.

C) lower price and have a higher yield to maturity.

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Bonds that are sold as part of a smaller issue have higher liquidity risk than bonds that are sold in a large issue. Investors will demand a higher yield to maturity to cover the liquidity risk; therefore, these bonds will be sold for less than bonds from larger issues.