What are credit spreads, What are credit spreads? Explain

What are credit spreads

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Reference no: EM132208060

Question - P&G issues mortgage-backed bonds backed by the mortgages on properties in a small county in US. Two of its issues are pass throughs of 10-year commercial mortgages with prepayment prohibitions as described below.

Issue A: Floating rate mortgage that pays the one month US T-Bill rate plus 200 basis points (net of service charge).

Issue B: Fixed rate mortgage issued at the 10-year US T-Bond rate plus 200 basis points (net of service charge).

Both issues currently trade at par.

If the economic conditions deteriorate only in the area where these properties are located, credit spreads on both pass throughs are likely to widen, given that the term structure of interest rates does not change during this period.

(a) What are credit spreads? Explain the factors that would influence the change of credit spread.

(b) Appraise the expected price change of the floating-rate bond (Issue A) relative to price change of the fixed-rate bond (Issue B). Support your answer.

Reference no: EM132208060

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