Answer:
Answer is given below.
Explanation:
Credit Risk
Investor stresses higher rate of return, when there is high anticipation that the borrower will run into default. Credit risk implies that the promised yield to maturity (YTM) is higher than the anticipated harvest. The difference between the assured yield and foreseeable yield is called default premium. The risk the bond issuer will run into insolvency is called credit risk or default risk.
The bond’s YTM will upsurge from 7.5%to 7.8% when the professed default risk upsurges.
The share value will fall:
see image 2 for a and image 3 for b.
Answer:
a. Is the bond likely to sell above or below par value before the downgrade: It is likely to sell above par.
b. Is the bond likely to sell above or below par value after the downgrade: It is likely to sell below par.
Explanation:
The bond is likely to sell above par if it offers a coupon rate higher than the market yield. On the other hands, it is likely to sell below par if it offers a coupon rate lower than the market yield.
It is because if the bond offer a lower coupon rate than the return of other similar risky assets, the investor is less likely to buy if issuer does not discount its selling price below par. Vice versa, if it offers coupon rate higher than the return of other similar risky asset, issuer can raise the bond's issuing price to some extend and the bond is still attractive for the investor to buy.
a.
As an Aa rated bond, the respective market yield to the bond should be 7.5%, while the coupon rate is 7.6%, so the bond is likely to sell above the par.
b.
As an A rated bond, the respective market yield to the bond should be 7.8%, while the coupon rate is 7.6%, so the bond is likely to sell below par.
