10. Bond ratings Rating agencies-such as Standard & Poor\'s (S&P), Moody\'s Inve
ID: 2808931 • Letter: 1
Question
10. Bond ratings 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 classified into investment-grade bonds and junk bonds. Which of the following bonds is likely to be classified as a junk bond? O A bond with a B rating, an 11% return on capital, a 87% total debt to total capital, and a 26% yield. O 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 upgraded a bond's rating. The yield on the bond is likely to the bond's price will and Assume you make the following investments: . A $10,000 investment in a 10-year T-bond that yields 5.50%, and . A $20,000 investment in a 10-year corporate bond with an BBB rating and a yield of 7.80% 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? 2.00% 3.40% 0 2.30% 2.80%Explanation / Answer
1.
Correct option is > A bond with a B-rating, an 11% return on capital, a 87% total debt to capital, and a 26% yield
Junk bond has rating lower than BBB i.e. B, high debt to capital ratio and high yield. Hence, above choice is correct.
2.
The yield on the bond is likely to decrease, and the bond’s price will increase
Reason: An upgrade in rating will decrease yield and price of bond will increase due to improved quality of bond.
3.
Correct option is > 2.00%
Default risk premium = Yield of the corporate bond - Risk free rate of T-Bond - Liquidity risk premium
Default risk premium = 7.80% - 5.50% - 0.30% = 2.00%
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