Fixed Income MCQ - Fixed Income Section 2

61 Which of the following is least likely a risk of relying on rating from credit rating agencies?

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?

A
Credit ratings are relatively stable over time even though the actual credit risk might have changed.
B
It is not easy to use credit ratings to compare bonds across different industries.
C
Credit ratings tend to lag market pricing of credit.

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.

63 An analyst observed that the market price of a bond changed faster than the credit rating of that bond. The limitation of credit agency ratings witnessed here is most likely:

The mentioned limitation is that credit ratings lag market pricing

64 A bond’s price did not fall when it was downgraded by Moody’s. Which of the The following is the most likely 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.

65 Company 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?

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.