Explanation:
B is correct because spread represents the excess return earned on a bond over the return provided by a reference security (such as Treasury securities).
A is incorrect: A positive spread indicates a higher return than the comparable Treasury bond, not lower. The spread represents excess return over the risk-free rate.
C is incorrect: Spreads are applied to the forward rate curve of the reference security, not directly to the yield to maturity of a Treasury bond.
D is incorrect: Spread differentials cannot be directly converted to price differences using simple percentage calculations. The relationship between spread and price is more complex and depends on the bond's duration and other factors.
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A bond fund manager has requested quotes from a bond dealer on two bonds, Bond X and Bond Y, with the same maturity date and coupon rate. The dealer informs the manager that Bond X trades at a spread of 30 bps over the Treasury market, while Bond Y trades at a spread of 70 bps. Which of the following statements is a correct conclusion for the manager to make?
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.