Two bonds have the same term to maturity. The first was issued by a state government and the probability of default is believed to be low. The other was issued by a corporation and the probability of default is believed to be high. Which of the following is correct?
A)Because they have the same term to maturity the interest rates should be the same.
B)Because of the differences in tax treatment and credit risk, the state bond should have the higher interest rate.
C)Because of the differences in tax treatment and credit risk, the corporate bond should have the higher interest rate.
D)It is not possible to say if one bond has a higher interest rate than the other.

Question

Quizplus · Accepted Answer

Corporate bonds typically offer higher interest rates than state government bonds due to the higher risk of default associated with corporations compared to state governments. Additionally, state bonds often have favorable tax treatment, which can further justify a lower interest rate compared to corporate bonds.

Two Bonds Have the Same Term to Maturity