Question

Consider two bonds:X and Y. Ceteris paribus, we would expect the yield on Bond X to be greater than the yield on Bond Y if the two bonds have identical characteristics except that: Select one: a. Bondy was issued by a corporation you consider to be financially strong; whereas Bond X was issued by a financially weak corporation ob. Bond y was issued by a country currently experiencing a financial crisis associated with a disastrous war; whereas Bond X was issued by the U.S. Treasury c. Bond y was issued by a corporation in a country currently experiencing inflation of 3 percent per annum whereas Bond X was issued by a country experiencing inflation of 1 percent per annum. d. None of the above is correct. In each scenario Bond X would be the lower yielding bond

Answer 1

The correct answer is option C as the bonds have identical characteristics so the nominal interest rates on both the bonds must be the same and in the given case yield on bond X is greater than the yield on bond Y. This clearly means that inflation in a country X is less than inflation in country B because, with a same nominal interest rate, yield ( directly associated with real interest rate) on bond X is greater than the yield on bond Y.

The inflation rate in country X is 1% and the inflation rate in country Y is 3%.

Inflation in country X is less than inflation in country Y, having the same nominal interest rate the real interest rate in country X will be higher than the country Y.

Real interest rate = Nominal interest rate - Inflation Rate

Therefore, the correct answer is option (C) Bond Y was issued by a corporation currently experiencing an inflation rate of 3 percent per annum; whereas Bond X was issued by a country experiencing an inflation rate of 1 percent per annum.