On the question below, can’t you argue that since Bond sector benchmark and treasury security reflect credit risk and liquidity risk but issuer specific benchmark reflects only liquidity risk, that the spread between issuer specific and the bond yield would be the greatest? Or are we to assume that the yield on a treasury security will still be lower even though it incorporates credit risk (since it’s the risk free rate)? Thanks guys! Which of the following benchmarks would generate the greatest spread when used to examine a bond yield? A) Bond sector benchmark. B) A U.S. Treasury security. C) The issuer of a specific company. Your answer: C was incorrect. The correct answer was B) A U.S. Treasury security. The U.S. Treasury security would generate the highest spread because the yield on Treasury securities will be the lowest as they have the lowest credit and liquidity risk. The yields on a bond sector benchmark and for a specific company will be higher.
Treasury securities are default-free securities and hence have no credit risk at all. Plus they are readily liquid as well, so liquidity risk is low compared to other benchmarks used, hence the greatest spread will be witnessed with the U.S. Treasury security.
yes, treasury securities do not have credit or liquidity risk, youre right. but using them as a benchmark incorporates that risk (precisely because they dont have that risk, while the bond you are evaluating does). please see page 210 of schweser book 4 if you are using their materials.
i just reread this and i guess i was thinking too much into it. its clear that DUE TO THE FACT THAT IT INCLUDES a credit risk factor, the spread of the treasury curve will be larger than that of the issuer specific benchmark. Not to mention that it is the risk free rate. easy question, my bed for misinterpreting.