Fixed Income Q135

135Company A and Company B, each have bonds outstanding with similar coupons and maturity dates. Both bonds are rated B1, B+, and B+ by Moody’s, S&P, and Fitch, respectively. The bonds, however, trade at very different prices — Company A bond trades at 78 USD, whereas the Company B bond trades at 62 USD.
What is the most likely explanation of the price difference?

A
Company B’s credit ratings are lagging the market’s assessment of the company’s credit deterioration.
B
The bonds have similar risks of default (as reflected in the ratings), but the market believes the Company A bond has a higher expected loss in the event of default.
C
The bonds have similar risks of default (as reflected in the ratings), but the market believes the Company B bond has a higher expected recovery the rate in the event of default.

Option : A
Explanation : Company B’s credit ratings are probably lagging behind the market’s assessment of its deteriorating creditworthiness. Answers B and C both state the situation backwards. If the market believed that the Company A bond had a higher expected loss given default, then that bond would be trading at a lower, not a higher, price. Similarly, if the market believed that the Company B bond had a higher expected recovery rate in the event of default, then that bond would be trading at a higher, not a lower, price.

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