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We would expect the interest rate on Bond A to be higher than the interest rate on Bond B if the two bonds have identical characteristics except that:________.
a. the credit risk associated with Bond A is lower than the credit risk associated with Bond B.
b. Bond A was issued by the city of Philadelphia and Bond B was issued by Red Hat Corporation.
c. Bond A has a term of 20 years and Bond B has a term of 2 years.
d. All of the above are correct.

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Answer: d. All of the above are correct.

Explanation:

Bonds with identical characteristics should have the same interest rates and if they do not, there are several reasons why this may the case.

Some of those are;

  • Credit Risk - Bonds with higher credit risks must have higher interest rates as well to compensate for the credit risk.
  • Type of Issuer - Generally, Government bonds are of lower rates than corporate bonds because Government bonds can be paid off with taxes so Bond A being issued by Philadelphia will make it have a lower rate than Bond B.
  • Term to Maturity - Bonds that have a longer term to Maturity will have higher interest rates as they are more exposed to market conditions. A bond with term 20 years will have a higher rate than one with 2.

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