Atlas Corporation is in sound financial condition. It sells a long-term bond. Which of the following make the interest rate on this bond lower than otherwise?

Question

BlackTom AI · Accepted Answer

Low default risk (strong creditworthiness) reduces the yield investors demand, while longer maturity usually increases yield because of interest-rate and inflation uncertainty. Key concepts: default (credit) risk premium, term (maturity) premium, and the basic decomposition of a bond’s yield.

Relevant knowledge points and concepts
- Yield decomposition: bond yield ≈ risk-free rate + default (credit) premium + term premium + liquidity premium. 
- A firm in sound financial condition has lower default risk → smaller default premium → lower required interest rate.
- A long-term bond carries greater interest-rate risk and greater uncertainty about inflation → larger term premium → higher required interest rate.

Step-by-step reasoning (with a simple numerical illustration)
1. Start from the decomposition: r = r_rf + p_default + p_term.
2. Assume risk-free rate r_rf = 3%. If Atlas were risky, p_default might be 3%; if sound, p_default might be 0.5%. For maturity, short-term p_term = 0.2%, long-term p_term = 1.0%.
3. Case A: Sound finances, long-term bond → r = 3% + 0.5% + 1.0% = 4.5%.
4. Case B: Sound finances, short-term bond → r = 3% + 0.5% + 0.2% = 3.7%.
5. Comparing to a risky firm with same long-term maturity: r = 3% + 3.0% + 1.0% = 7.0%. The low default premium from sound finances clearly lowers the yield relative to a risky issuer, while the long term itself increases the yield relative to a short-term issue.

Why the correct answer is correct
- Atlas’ sound finances reduce the default premium, which lowers the bond’s interest rate relative to an otherwise similar but less creditworthy issuer.
- The long term of the bond increases the term premium, which would raise (not lower) the interest rate. Therefore only sound finances make the rate lower than it otherwise would be.

Why the other choices are incorrect
- “Neither …” is wrong because creditworthiness does affect yield.
- “Both …” is wrong because the long term does not lower the rate—it raises it.
- “The long term … but not Atlas' sound finances” is wrong because long maturity raises yields and sound finances do lower yields.

Final confirmation: The correct choice is “Atlas' sound finances but not the long term of the bond.”

Atlas Corporation is in sound financial condition. It sells a long-term bond. Which of the following make the interest rate on this bond lower than otherwise?单项选择题

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