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Explanation:
The correct answer is A.
Credit Spread = RD − Rf = −(1/T) × ln(D/F) − Rf
Where
RD = Yield of the debt
Rf = Risk-free rate
T = Time to maturity
F = Face value
D = Debt value
Therefore,
Credit spread = −(1/3) × ln(40,000,000 / 45,000,000) − 0.025
= −0.33 × −0.1178 − 0.025 = 0.014266 ≈ 1.43%
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Q.5442 RedRose Group has zero coupon bonds with a face value of $45,000,000 and a current market value of $40,000,000. These bonds mature in 3 years while similar risk-free bonds have a continuously compounded yield of 2.5% per annum. The average credit spread of RedRose's bonds is closest to?
A
1.43%
B
2.50%
C
3.33%
D
1.17%