A bond portfolio manager is considering three Bond
A bond portfolio manager is considering three Bonds – A, B, and C – for his portfolio. Bond A allows the issuer to call the bond before stated maturity, Bond B allows the investor to put the bond back to the issuer before stated maturity, and Bond C contains no embedded options. The bonds are otherwise identical. The manager tells his assistant, “Bond A and Bond B should have larger nominal yield spreads to a U.S. Treasury than Bond C to compensate for their embedded options.” Is the manager most likely correct?
A. Yes.
B. No, Bond A’s nominal yield spread should be less than Bond C’s.
C. No, Bond B’s nominal yield spread should be less than Bond C’s.
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2024-11-14 18:00:11
Ans:C;A call option benefits the bond issuer so yield spreads will be higher for a callable bond compared to the same bond without a call feature;A put option allows the bond holder to put the bond back when the price of the bond goes lower so the bond holder will require a lower yield spread for a putable bond than an option-free bond.Therefore C is correct because Bond B’s embedded put option benefits the bondholder and the yield spread will therefore be less than the yield spread of Bond C, which does not contain this benefit.
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