An investor is comparing two bonds: Bond A has a higher coupon rate but a lower credit rating than Bond B. Which factor is most likely to explain why Bond A offers a higher yield than Bond B?

• A. Bond A is issued by the government.
• B. Bond B has a shorter maturity.
• C. Bond A carries higher default risk.
• D. Bond B pays interest less frequently.

Answer: (C)

Verified step by step guidance

1. Understand the concept of bond yield: Bond yield is the return an investor earns on a bond, typically expressed as a percentage. It is influenced by factors such as coupon rate, credit rating, maturity, and default risk.
2. Analyze the relationship between credit rating and yield: Bonds with lower credit ratings are considered riskier because they have a higher likelihood of default. To compensate investors for taking on this risk, these bonds typically offer higher yields.
3. Examine the coupon rate: A higher coupon rate means the bond pays more interest to the investor. However, this alone does not explain the higher yield if the bond carries higher default risk.
4. Consider the default risk: Bond A has a lower credit rating, which indicates higher default risk. This is the primary reason why Bond A offers a higher yield compared to Bond B, as investors demand higher returns for taking on greater risk.
5. Evaluate other factors: While maturity, payment frequency, and issuer type can influence bond yields, the most relevant factor in this scenario is the higher default risk associated with Bond A.