the heart that rating agencies have upgrade a bond\'s raTING. THE YIELD ON THE B
ID: 2743355 • Letter: T
Question
the heart that rating agencies have upgrade a bond's raTING. THE YIELD ON THE BOND IS LIKELY TO......(DECREASE/INCREASE) AND THE BOND S PRICE WILL (DECREASE/INCREASE)
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. bonds is likely to be classifed as a junk bond 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? A bond with a BBB rating, a 14% return on capital, a 42% total debt to total capital, and a 10% yield. O A bond with a B rating, an 11% return on capital, a 87% total debt to total capital, and a 26% 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 13.5%, and · A $20,000 investment in a 10-year corporate bond with an BBB rating and a yield of 17.6% Based on this information, what is your estimate of the corporate bond's default risk premium? O 4.5% O 6.2% 0 4.1% o 5.7%Explanation / Answer
Solution for 1st part:
Correct option is > A bond with a B rating, an 11% return on capital, 87% total debt to capital, and a 26% yield
Reason: A high yield of 26% and low rating as B, and high total debt capital of 87% are clear indicator of junk classification.
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Solution for 2nd part:
Correct option is > You heard that rating agencies have upgraded a bond’s rating. The yield on bond is likely to decrease, and the bond price will increase
Reason: Bond price increases with decrease in yield rate and vice versa.
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Solution for 3rd part:
Correct option is 3rd option > 4.1%
Working:
BBB rating bond yield – T Bond yield
17.6% - 13.5% = 4.1%
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