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FRM Part I · FRM Exam Part I · Corporate Bonds

Compared with a similar-maturity, same-rating bond that trades actively, an illiquid corporate bond will generally exhibit which of the following?

An illiquid corporate bond generally has a higher yield spread, because investors demand a liquidity premium for wider bid-ask spreads and difficulty selling. Credit rating is not the sole driver of spreads, and higher transaction costs push required yields up rather than down.

  1. AA higher yield spread because investors demand a liquidity premiumCorrect
  2. BA lower yield spread because dealers hold it longer
  3. CAn identical spread because credit rating alone determines spread
  4. DA lower yield spread because transaction costs are higher

Explanation

Investors require compensation for higher trading costs and difficulty exiting positions, so the illiquid bond's spread is wider. Rating alone does not determine spread, and higher transaction costs raise, not lower, the required yield.

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