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.
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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.
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- Option : A
- Explanation : The mentioned limitation is that credit ratings lag market pricing
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- 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.
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- 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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