l. What is a bond spread and how is it related to the default risk premium? How are bond ratings related to default risk? What factors affect a bond company’s rating? Answer: A is often calculated as the difference between a corporate “bond spread” bond’s yield and a Treasury yield of the same maturity. Therefore: security’s Spread = DRP + LP. of large, strong companies often have very small LPs. of small Bond’s Bond’s companies often have LPs as high as 2%. Bond ratings are based upon a default risk. They are based on both company’s qualitative and quantitative factors, some of which are listed below. 1. Financial performance--determined by ratios such as the debt, TIE, FCC, and current ratios. 2. Provisions in the bond contract: A. Secured vs. Unsecured debt B. Senior vs. Subordinated debt C. Guarantee provisions D. Sinking fund provisions E. Debt maturity 3. Other factors: A. Earnings stability B. Regulatory environment C. Potential product liability D. Accounting policy
l. What is a bond spread and how is it related to the default risk premium? How are bond ratings related to default risk? What factors affect a company’s bond rating? Answer: A “bond spread” is often calculated as the difference between a corporate bond’s yield and a Treasury security’s yield of the same maturity. Therefore: Spread = DRP + LP. Bond’s of large, strong companies often have very small LPs. Bond’s of small companies often have LPs as high as 2%. Bond ratings are based upon a company’s default risk. They are based on both qualitative and quantitative factors, some of which are listed below. 1. Financial performance--determined by ratios such as the debt, TIE, FCC, and current ratios. 2. Provisions in the bond contract: A. Secured vs. Unsecured debt B. Senior vs. Subordinated debt C. Guarantee provisions D. Sinking fund provisions E. Debt maturity 3. Other factors: A. Earnings stability B. Regulatory environment C. Potential product liability D. Accounting policy