Fixed Income - Fixed Income Section 2
61. Which of the following is least likely a risk of relying on rating from credit rating agencies?
- Option : B
- Explanation : Among the mentioned list the “default risk is difficult to assess” is not the risk of relying on ratings from the credit rating agencies.
62. Which of the following is least likely to be a limitation of a credit rating agency’s ratings?
- Option : B
- Explanation : Options A and C are true statements and represent the limitations of credit ratings. Option B does not represent a limitation. Credit ratings can be used to compare bonds across different industries.
- Option : C
- Explanation : The market was anticipating the rating downgrade and had already priced it in. Bond prices often do react to rating changes, particularly multi-notch ones. Even if bonds don’t trade, their prices adjust based on dealer quotations given to bond pricing services.
- 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.
