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Answer: The price of Bond X is currently higher than the price of Bond Y.
The correct answer is B. The spread is a measure of the excess return that a bond offers over a reference security, such as Treasury securities. It is used to adjust the discount rates applied to a bond's cash flows. A higher spread indicates a lower discount factor, which in turn results in a lower bond price. Since Bond X has a spread of 30 basis points (bps) and Bond Y has a spread of 70 bps, Bond X will have a higher price than Bond Y due to its lower spread. This is because the discount rates used for Bond X's cash flows will be lower than those for Bond Y, leading to a higher present value for Bond X. Therefore, the conclusion that Bond X's price is currently higher than Bond Y's price is correct.
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A bond fund manager has approached a bond dealer to gather details regarding the prices of two bonds, specifically Bond X and Bond Y. Both bonds have identical maturity periods and coupon rates. According to the dealer’s report, Bond X is being quoted at a spread of 30 basis points above the corresponding Treasury rate, while Bond Y carries a spread of 70 basis points above the Treasury rate. Based on this information, what accurate conclusion can the manager draw about the relative risk or quality of these bonds?
A
Bond X earns a lower return than that of the comparable Treasury bond, since its spread serves to increase the discount rate of its cash flows.
B
The price of Bond X is currently higher than the price of Bond Y.
C
To equate the present value of Bond Y's cash flows to its face value, 70 bps would need to be added to the yield to maturity of a Treasury bond with comparable maturity.
D
The spread differential indicates that there is a 0.4% difference in price between Bond X and Bond Y.
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