Question

A bond's credit ratingt provides a guides to its risk. suppose that long term bonds Aa currently offers yield to mjaturity of 7.5%. A-rated bonds sell at yields of 7.8%. Sud- pose that a 10-year bond with a coupon rate of 7.6% is downgraded by Moody's from an Aa to A rating.

Required:
a. Is the bond likely to sell above or below par value before the downgrade?
b. Is the bond likely to sell above or below par value after the downgrade?

Answer 1

a.- above par (premium)

b.- below par (discount)

Step-by-step explanation:

Currenly the bonds par yield will be of 7.6%

Before the downgrade the expected return on that risk was 7.5% so it was above par.

Once the downgrade occurs: the expected return considering the increased risk is 7.8% Therefore the market price will decrease. This will move the yield to maturity from 7.5% to 7.8% and the market price below par.