IAI Actuarial Core Principles · Economic Modelling · Simple models for credit risk
A one-year zero-coupon corporate bond issued by an Indian firm has a continuously compounded yield of 7.5% per annum. A one-year risk-free zero-coupon government bond has a continuously compounded yield of 6.0% per annum. What is the credit spread on the corporate bond?
The credit spread is 1.5% per annum. It equals the corporate bond yield of 7.5% minus the risk-free yield of 6.0% for the same term, and measures the extra return demanded for bearing default risk.
- A0.75%
- B1.25%
- C1.50%Correct
- D6.75%
- 13.50%
Explanation
The credit spread is the corporate yield less the risk-free yield over the same term. 7.5% - 6.0% = 1.5%. The 6.75% option is the average of the two yields, which has no meaning here, and 13.50% adds them instead of subtracting.
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