CFA Practice Question

CFA Practice Question

A portfolio manager with Ivy League Securities is examining an outstanding bond issue of a large automobile manufacturer. These bonds feature a 7% coupon rate and are priced to yield 6.30%. The comparable on-the-run Treasury issue was yielding 5.32% on the same date. What is the relative yield spread between these two securities? Further, what are the absolute yield spread and the yield ratio, respectively?
A. 15.56%; 168 basis points; 1.184
B. 15.56%; 98 basis points; 1.184
C. 18.42%; 98 basis points; 1.184
Explanation: To determine the relative yield spread between two securities, use the following equation:
{Relative yield spread = [(yield on security A - yield on security B) / yield on security B]}
where B is the lower yielding issue. (Typically, Bond B will be the comparable on-the-run Treasury Issue.)
Incorporating the given information into this equation will yield the following:
{Relative yield spread = [(0.0630 - 0.0532) / 0.0532] =18.42%

The determination of the absolute yield spread is straightforward. To calculate the absolute yield spread, use the following equation:
{Absolute yield spread = [yield on security A - yield on security B]}
The calculation of the absolute yield spread in this equation is shown below:
{Absolute yield spread = [0.0630 - 0.0532] = 0.0098}, or 98 basis points

Finally, the calculation of the yield ratio can be found by using the following equation:
{Yield ratio = [yield on security A / yield on security B]}
where security B is the lower yielding issue. Notice that the yield ratio should always be equal to or greater than one. (Typically, Bond B will be the comparable on-the-run Treasury Issue).
Incorporating the given information into this equation will yield the following:
{Yield ratio = [0.0630 / 0.0532] = 1.184211}

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