10. Bond ratings Aa Aa Rating agencies-such as Standard & Poor’s (S&P), Moody’s Investor Service, and…
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Question “10. Bond ratings Aa Aa Rating agencies-such as Standard & Poor’s (S&P), Moody’s Investor Service, and…”
Answer
1) Based on credit ratings, the Junk bond that will be classified in the above question is a bond with B
rating.
Based on their rating, bonds can be either investment-grade or junk-grade. BBB bonds are medium-risk bonds, while B bonds are high-risk bonds. A junk bond has higher yields than investment-grade corporate bonds and is considered high risk. In the above example, the Junk bond with a B rating and 26% yield would be the Junk bond
2) Downgrading a bond rating: The bond’s yield is likely to HTML1$, and the bond price will be DECREASE.
If a downgrade is made, the likelihood of defaulting on payments (credit risk), increases. Investors expect a higher return on bonds due to higher credit risk. The yield will rise as a result. The relationship between price and yield is inverted. Therefore, the bond price will drop.
3) Based upon the following details:
Corporate Bond Default Premium = Annualized percentage Yield – Risk-free Rate – Liquidity premium
= 7.2% – 5.5%-0.4% = 1.30 %
Conclusion
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