SIE exam question

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?

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Hi @Pleasant_copper_hors! I’m happy to help with this question.

Unfortunately, there’s no good answer to your question. Why? It depends on your definition of the word ‘best.’

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 don’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 it’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 B’s coupon is 2% higher than Bond A’s. Although we don’t have bond prices, we should probably again assume Bond B provides a higher rate of return than Bond A.

In summary, here’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 “best” 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 investor’s profile.

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

Thanks

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