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ID: 2620035 • Letter: M
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me om/af/servlet/quiz?quiz action-takeQuiz&quiz; probGuid-QNAPCOA8010100000041ebc5300900008ctx ream-00578ck Graded Assignment Read Chapter 7 | Back to Assignment Due Sunday 07.08.18 at 11:45 PNM Attempts Keep the Highest:/4 6. Bond ratings Aa Aa Rating agencies-such as Standard & Poor's (S&P;), Moody's Investor Service, and Fitch Ratings-assign credit ratings to bonds based on both quantitative and qualitative factors. These ratings are considered indicators of the issuer's default risk, which impacts the bond's interest rate and the issuer's cost of debt capital. Based on these ratings, bonds are classfied into investment-grade bonds and junk bonds. Which of the following bonds is likely to be classified as a junk bond? A bond with a B rating, an 11% return on capital, a 87% total debt to total capital, and a 26% yield A bond with a BBB rating, a 14% return on capital, a 42% total debt to total capital, and a 10% yield You heard that rating agencies have downgraded a bond's rating. The yield on the bond is likely to and the bond's price will Assume you make the following investments: A $10,000 investment in a 10-year T-bond that yields 7.50%, and * A $20,000 investment in a 10-year corporate bond with an BBB rating and a yield of 9.80% Based on this information, and the knowledge that the difference in liquidity risk premiums between the two bonds is 0.30%, what is your estimate of the corporate bond's default risk premium? 2.80% 3.40% ? 2.30% ? 2.00% Flash Payer WIN 30,4,0,113 033 34 1 2004-2016 Aplis, A nights eserved DOLL F2 F3 F4 F5 F6 F7 F8 F9 F10 F11 F12Explanation / Answer
Junk bonds are risky bonds. These bonds give high yield and greater risk than other bonds.
Hence, correct option is “A bond with a B rating, an 11% return on capital, a 87% total debt to capital, and a 26% yield”
Bond rating and bond yield has inverse relationship. If bond rating increase bond yield will decrease and vice-versa. Bond yield and bond price has inverse relationship. If bond yield decrease bond price will increase and vice-versa.
Hence, “The yield on the bond is likely to increase and the bond price will decrease.”
Default risk premium:
= Yield on corporate bond – Yield on T bond-Liquidity risk premium
= 9.80%-7.50%-0.30%
= 2.00%
Hence, correct option is 2.00%
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