Question

You are a newly hired analyst at one of the leading bond rating agencies, Standard and Poor’s. The first day on the job you are asked to rate the following bonds: a. The bonds of an Internet start-up company b. The bonds of a country with a history of inflation and political instability c. The bonds of company operating a network of toll highways d. The bonds of a company with a long illustrious history that has fallen on hard times e. The bonds of a stable, rich country with no history of inflation Rank these bonds from highest credit quality to lowest credit quality and explain your ranking. [There are several defensible rankings. Your grade will be influenced by the quality of your reasoning as well as the adequacy of your ranking.]

Answer 1

Rank 1: The bonds of a stable, rich country with no history of inflation : This should be the highest rated bond since the bond is provided by the country which is theoretically considered risk free many time. Also the country is in good economic conditions with no level of inflation.

Rank 2: The bonds of company operating a network of toll highways : This should be considered as 2nd rank, as the company can easily provide consistent cashflows which is necessary to pay the bond interest. Since the company is operating a toll highway, the variability of cashflow will be minimum and hence the bond can be rated high

Rank 3: The bonds of a country with a history of inflation and political instability: Rank 3 and 4 are debatable. Although as per the analysis, it will be easier for a country as a whole to payback its debts rather than only considering one single company. Hence eventhough high inflation and instability is present, it can be managed with charging high interest rates as there is relatively better guarantee in paying back the debts.

Rank 4: The bonds of a company with a long illustrious history that has fallen on hard times: Since even though under current crisis, the management has already proven their efficiency in handling a big company for a long period. Hence given there is capital the expectation is that the company can recover from the crisis and payback its debt. The lower rating is due to the current uncertainity.

Rank 5: As this is a startup, they have long way to prove themselves and are in growth phase. The uncertainity is huge in startups and the chance of making a success is very low. Hence the lowest rating.