Question

2. 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?  

A bond with a BBB rating, 14% return on capital, 42% total debt to total capital, and a 10% yield 

A bond with a B rating, 11% return on capital, 87% total debt to total capital, and a 26% yield 

You heard that rating agencies have downgraded a bond's rating. The yield on the bond is likely to and the bond's price will. 

Assume you make the following investments: 

 A $10,000 investment in a 10-year T-bond that has a yield of 10.5% . 

A $20,000 investment in a 10-year corporate bond with an A rating and a yield of 13.7%.

Based on this information, what is your estimate of the corporate bond's default risk premium? 

3.2%  

4.5%  

4.8%  

3.5%

Answer 1