Reading 61: Risks Associated with Investing in Bonds- LO

principal

LOS j: Describe the various forms of credit risk and describe the meaning and role of credit ratings.

Q1. Which of the following statements is TRUE?

A) Default risk is important because if a bond issuer defaults, the bondholder likely loses his entire investment.

B) Technical default usually refers to the issuer's failure to make interest or principal payments as scheduled in the indenture.

C) When a rating agency downgrades a security, the bond's price usually falls.

Q2. Credit risk is measured in several ways. The yield differential above the return on a benchmark security measures the:

A) credit spread risk.

B) default risk.

C) recovery rate.

Q3. When planning to hold a coupon-paying Treasury bond until maturity, which of the following types of risk would be the most important?

A) Reinvestment.

B) Default.

C) Interest rate.

Q4. With respect to bond investing, reinvestment risk is a very important component of what other type of risk?

A) Liquidity risk.

B) Default risk.

C) Call risk.

Q5. Which of the following will most likely have the least impact on a corporate bond rating? The:

A) issuing company's volume of sales.

B) issue's indenture provisions.

C) issuing company's debt burden.

Q6. Suppose that a corporate bond and a government bond have equivalent characteristics. They both have a coupon rate of 6% paid annually and have two years remaining to maturity. Assuming a flat government term structure of 7% which of the following is a possible price of the corporate bond?

A) 97.76.

B) 98.19.

C) 101.35.

Q7. Benjamin Zoeller and Tara McGonigal are preparing for the Level I CFA examination. Zoeller is studying credit spread risk. McGonigal is farther along in her studies, but has forgotten how to determine the default free rate if given the yield on a bond rated BBB+ of 9.50% and a risk premium of 3.00%. What does Zoeller tell her to use for the default free rate?

A) 6.50%.

B) 9.50%.

C) 12.50%.

Q8. When determining credit risk spread, the benchmark security is most likely a(n):

A) AA rated bond.

B) high-yield corporate bond.

C) Treasury bond.