medium · Debt Capital Markets credit-ratings-risk
An analyst is comparing two bonds from the same issuer. Bond X is a 5-year senior secured bond with a 4.0% coupon. Bond Y is a 5-year senior unsecured bond with a 5.5% coupon.
What is the most likely driver of the 150 bps spread difference?
- Probability of Default (PD); the unsecured bond is more likely to default than the secured bond due to its higher interest expense.
- Negative Convexity; Bond X likely embeds a call option that the market values at 150 bps.
- Modified Duration; the higher coupon of Bond Y makes it more sensitive to interest rate changes.
- Loss Given Default (LGD); the secured bond has collateral that significantly improves its recovery rate in a bankruptcy scenario.
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