Problems 1) The Z score is 2. Explicate the meaning of the different determinant

Question

Problems

1) The Z score is 2. Explicate the meaning of the different determinants of the Z score. Will this company default?

2) There is a 10%, 3 year note bond which has a ytm of 9%. The ytm alters by half a percent down. By how much does the price alter? If the ytm drops by 2%, by how much does the price change, if the convexity is 40?

Essays

a) Compare liquidity risk to default risk.

b) Analyze the determinants of systematic risk.

c) Compare and contrast unsystematic and systematic risk. What values have the betas of bonds got in comparison to stocks?

d) Expound on the determinants of default risk.

e) Discuss four qualitative variables from Jane Howe, which influence the value of bonds.

f) Compare and contrast general obligation to revenue bonds.

g) Explain how inflation and monetary policy affect the price of bonds.

h) Talk on how William Beaver approached the prediction of bankruptcy of bonds.

i) Discuss the two types of bankruptcy in terms of investors and other stakeholders.

j) Elaborate on the determinants of duration.

k) What are the assumptions in order to use duration alone?

Please support your work with clear answers for a better undertanding! Thank you in advance!

Explanation / Answer

Answer(a)- Liquidity Risk- It is the risk about the marketability of the financial instruments. When any investment cannot be bought or sold quickly and easily, when there is huge gap between bid and ask price, is called Liquidity risk. It is associated with the market.

Default risk- It is the risk associated with the debtor in non repaying the debt obligation. When there is risk that one or more debtor may not repay the debt or loan, is called the default risk. It is associated with one of the parties of Investment instrument.

Answer(b)- Systematic Risk- It is the risk, associated with the overall market. It is undiversifiable and uncontrollable risk. Interest rates, recession, unemployment, less economic growth, fiscal and monetary policy are the main source of systematic risk. This risk affects overall market, industries and companies. Stock market index is affected by systematic risk.

Answer(c) Unsystematic Risk- It is risk, associated with the particular company and industry. It is called specific risk. It does affect overall market but the company or industry to which it pertains to.

Difference between unsystematic and systematic risk-

Answer(g) Impact of Inflation and monetary policy on Bonds- When inflation increases, Federal reserve increases the rates of interest so as to lower the demand of credit. Long and short term interest rates are hiked and due to this yield increases and the price of bond decreases.

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