ABC is a BBB+ rated company whose bonds have a 10-year maturity and trade at 5.0% yield.

XYZ is an AA- rated company whose bonds also have a 10-year maturity and trade at a 5.5% yield.

Apply the concept of no free lunch to explain if this situation is possible

Notes on: No Free Lunch

Markets are competitive - meaning that there is no free lunch meaning that its very difficult to find securities that are so underpriced that they represent great bargains. The no free lunch has two key implications lets examine some of these:

1)Risk return tradeoff: investments that have high expected return are also high risk. Its difficult to find an investment with low risk that has a high expected return.

2) Efficient markets: difficult if not impossible to find underpriced securities.

3)Market timing between stocks, bonds and cash. Difficult to get right since you have to be right twice in a row. Elaine Garzarelli

Risk return trade off

Higher returns -- higher risk

Cant have a high expected return with very low risk