SIE exam question

FINRA FINRA SIE
1

Hello, can you please answer this question?:

There are these 2 bonds:
A. | B
Rating: Aaa | ccc
Maturity: 2030 | 2023
Interest rate: 6% | 8%

What is the main factor to determine which one is the best option: rating, maturity, or interest rate?

1 Like
2

Hi @Pleasant_copper_hors! Iā€™m happy to help with this question.

Unfortunately, thereā€™s no good answer to your question. Why? It depends on your definition of the word ā€˜best.ā€™

Bond A has a better debt rating, making it a safer bond in regards to default risk. However, it has a longer maturity, making it more susceptible to interest rate risk and price volatility. While we donā€™t know the yield of the bond (overall rate of return), we do know the interest rate (coupon), which is lower than Bond B. I think itā€™s safe to assume Bond A would provide a lower rate of return than Bond B.

Bond B has a much lower debt rating, subjecting it to high levels of default risk. However, it has a shorter maturity, making it less susceptible to interest rate risk and price volatility. Bond Bā€™s coupon is 2% higher than Bond Aā€™s. Although we donā€™t have bond prices, we should probably again assume Bond B provides a higher rate of return than Bond A.

In summary, hereā€™s what we know:

  • Bond B is subject to higher levels of default risk
  • Bond A is subject to higher levels of interest rate risk
  • Bond B provides a higher rate of return

Which is ā€œbestā€ ultimately depends on the investor. Bond A would be suitable for a conservative investor seeking long-term income, while Bond B would be suitable for a moderate-to-aggressive investor seeking higher yields in the short term.

Hopefully this answers your question. The best option is dependent on two big factors - the characteristics of the security and the investorā€™s profile.

2 Likes
3

Yes, so it depends on what the investor is looking for.

Thanks

1 Like