Use of Matrix Pricing in Calculating Spread Over Benchmark

To determine the appropriate coupon rate for a newly issued 10-year corporate bond, underwriters began with a benchmark rate, for which they used the yield on a government bond, and then added a required yield spread. Relative to the corporate bond, the government bond _most likely_ has:

Correct. Government bonds are typically considered by investors to be risk-free securities. Because sovereign governments have the ability to print additional currency, the probability of default on their bonds is considered to be extremely low and certainly lower than the probability that corporate issuers will default on their debt obligations.

Incorrect. Relative to corporate bonds, government bonds trade much more frequently in secondary markets. The required yield spread on corporate bonds is, in part, a reflection of the additional liquidity risk that investors take in holding these bonds rather than government bonds.

Incorrect. When determining an appropriate coupon rate or required yield for a corporate bond, underwriters and investors start with a benchmark rate, which is typically the yield on a government bond with the same time-to-maturity. Governments regularly issue new 10-year bonds and the yields on the latest issue are readily available. It would therefore be unnecessary to use the yield on a longer-maturity government bond as the benchmark rate for this newly issued 10-year corporate bond.

lower credit risk.

greater liquidity risk.

a longer time-to-maturity.