Order of Bonds by Yield

Explanation

To determine the correct order of the three bonds from highest yield to lowest yield, we need to analyze the impact of the listed characteristics on the yield of each bond.

1. Bond X: Noncallable, accelerated sinking fund Bond X is noncallable, which means that the issuer cannot redeem the bond before its maturity date. This characteristic generally makes a bond more attractive to investors because it provides certainty of cash flow over the bond's life.

In addition, Bond X has an accelerated sinking fund. A sinking fund is a provision that requires the issuer to set aside money periodically to retire a portion of the bond issue. An accelerated sinking fund implies that the issuer will retire a larger portion of the bond issue earlier than the regular sinking fund schedule. This provision benefits bondholders by reducing the credit risk associated with the bond, making it more attractive.

Overall, the noncallable feature and the accelerated sinking fund of Bond X are both positive characteristics that enhance its desirability, resulting in a lower yield.

2. Bond Y: Nonrefundable, callable, accelerated sinking fund Bond Y is nonrefundable, which means that the issuer cannot redeem the bond prior to maturity at the option of the bondholder. This feature typically provides more security to bondholders because they have the assurance that the bond will not be redeemed early.

However, Bond Y is callable, which means that the issuer has the right to redeem the bond before maturity at a specified call price. Callable bonds are generally less attractive to investors because there is a risk that the issuer will call the bond when interest rates decline, potentially forcing investors to reinvest their funds at lower interest rates.

Similar to Bond X, Bond Y also has an accelerated sinking fund. This feature provides the same credit risk reduction benefits as mentioned before.

The nonrefundable feature of Bond Y is positive for investors, but the callable feature introduces some uncertainty and potential reinvestment risk. The presence of the accelerated sinking fund partially offsets the negative impact of the callable feature.

3. Bond Z: Noncallable, no sinking fund Bond Z is noncallable, which, as discussed earlier, is a positive characteristic for investors. It provides certainty of cash flow over the bond's life.

However, Bond Z does not have a sinking fund provision. A sinking fund typically enhances the creditworthiness of a bond by ensuring regular repayment of a portion of the principal. The absence of a sinking fund in Bond Z means that there is no specific provision for the issuer to retire a portion of the bond issue before maturity. This lack of a sinking fund can make the bond slightly less attractive to investors, as it increases the credit risk associated with the bond.

In summary, the correct order for the three bonds, from highest yield to lowest yield, is:

B. Bond Y; Bond Z; Bond X.

Bond Y has the highest yield because it carries the risk of being called by the issuer, potentially forcing investors to reinvest at lower interest rates. The presence of an accelerated sinking fund partially offsets this risk.

Bond Z has the second-highest yield as it lacks the credit risk reduction benefits of a sinking fund.

Bond X has the lowest yield due to its noncallable feature and the presence of an accelerated sinking fund, which enhance its attractiveness to investors.