Learning objectives: Describe different characteristics of bonds such as issuer, maturity, interest rate, and collateral. Describe the mechanisms by which corporate bonds can be retired before maturity. Define recovery rate and default rate, and differentiate between an issue default rate and a dollar default rate. Evaluate the expected return from a bond investment and identify the components of the bond’s expected return.
Questions:
23.2.1. Acme Industrial Corporation is considering issuance of new corporate debt. Among the following bond issuance types, which is most likely to earn its investors the highest yield?
a. Senior bond with an indenture
b. Subordinated debenture with few covenants
c. Subordinated debenture with many covenants
d. Commercial mortgage-backed security with an embedded call
23.2.2. Barbara is a portfolio manager who is going to allocate some of the fixed-income portfolios that she manages to high-yield (aka, speculative) bonds. If she decides to invest in a set of high-yield bonds, which of the following is necessarily TRUE about them?
a. These firms have poor prospects
b. These bonds, by definition, were never investment-grade
c. These bonds have at one two unusual features (e.g., payment-in-kind) and will be priced at a discount (i.e., below par)
d. The external credit ratings of these bonds fall below investment grade; ie., below Baa3 (Moody's) or below BBB- (S&P and Fitch)
23.2.3. A high-yield corporate bond has a default probability of 3.0% with an expected recovery rate of 30.0%. The credit spread is defined as spread above the risk-free rate. In regard to this credit spread which of the following is most likely to be TRUE?
a. We expect to observe a credit spread less than 0.90%
b. We expect to observe a credit spread less than 2.10%
c. We expect to observe a credit spread greater than 2.10% due primarily to systematic risk
d. We expect to observe a credit spread greater than 2.10% due primarily to the low recovery rate
Answers:
Questions:
23.2.1. Acme Industrial Corporation is considering issuance of new corporate debt. Among the following bond issuance types, which is most likely to earn its investors the highest yield?
a. Senior bond with an indenture
b. Subordinated debenture with few covenants
c. Subordinated debenture with many covenants
d. Commercial mortgage-backed security with an embedded call
23.2.2. Barbara is a portfolio manager who is going to allocate some of the fixed-income portfolios that she manages to high-yield (aka, speculative) bonds. If she decides to invest in a set of high-yield bonds, which of the following is necessarily TRUE about them?
a. These firms have poor prospects
b. These bonds, by definition, were never investment-grade
c. These bonds have at one two unusual features (e.g., payment-in-kind) and will be priced at a discount (i.e., below par)
d. The external credit ratings of these bonds fall below investment grade; ie., below Baa3 (Moody's) or below BBB- (S&P and Fitch)
23.2.3. A high-yield corporate bond has a default probability of 3.0% with an expected recovery rate of 30.0%. The credit spread is defined as spread above the risk-free rate. In regard to this credit spread which of the following is most likely to be TRUE?
a. We expect to observe a credit spread less than 0.90%
b. We expect to observe a credit spread less than 2.10%
c. We expect to observe a credit spread greater than 2.10% due primarily to systematic risk
d. We expect to observe a credit spread greater than 2.10% due primarily to the low recovery rate
Answers:
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