What factors affect the level of risk for bankruptcy in a firm? (Select all that apply)...

What factors affect the level of risk for bankruptcy in a firm? (Select all that apply)

A. Liquidity B. Stock price C. Leverage D. The company’s bond rating

What is the effect of interest rate changes on bond prices? (Select all that apply)

A. Long-term bond prices fall at an increasing rate as interest rates rise B. Interest rate changes have a greater effect on bonds with longer maturities C. A rise in interest rates leads to a rise in market price D. A fall in interest rates leads to a rise in market price

Expert Solution

1) All the alternatives are applicable.

A) Liquidity : If liquidity goes down then company's risk of bankruptcy may increase due to shortage of liquid assets for meeting on time financial commitments

B) Stock price : Stock price is the result of market supply and demand for shares. When stock price decreases at large, it means there is almost no demands of the shares in the market, which creates problems for further issuance of stock for additional fund raising and may stand alone as a risk of bankrupty.

C) Leverage : Proportion of debt and equity in capital structure is called leverage. If proportion of debt increases then it may be the cause of bankruptcy risk.

D) Higher rated bonds have lower interest rate, but unsecured bonds of non reputed companies are normally called unrated or poor rated bonds. These bonds are associated with higher rate of fixed interest ,which ultimately effect the risk of bankruptcy.

2) A), B) and D) are the correct alternatives .

A) When market interest increases then bond price falls. It has an inverse relationship .

B) Longer maturity bonds are very much price sensitive because the period of maturity is too large.

D) If interest rate falls then investors wanted to purchase bond with pre established coupon rate which is more than the current market rate. It creates more demand of the bonds and thus market price of the bond increases.

C) Rise in interest rate always decrease the market price of the bonds. Because when interest rate increase then investors have different alternatives for investment in the market, they wants to sell their bonds and reinvest their money in different investment proposal .

ekkarill92 answered 2 years ago

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