Question 1

Briefly explain the term junk bonds.

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Question 2

The firm's right to default on a bond generally increases with the maturity of the bond.

Accepted Answer

The longer the maturity of a bond, the greater the uncertainty and potential for changes in the issuer's financial condition, increasing the risk of default.

Question 3

What is a credit default swap? Briefly explain.

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Question 4

What is a major drawback to value-at-risk calculations?

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Question 5

Briefly explain the model developed by Beaver,McNichols,and Rhie to predict the chance of failure of a firm.

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Question 6

Briefly explain the term credit scoring.

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Question 7

Suppose that the possibility of default on a firm's bond is totally unrelated to other events in the economy.In this case,the beta of the bond will equal zero and the discount rate will equal the risk-free rate.

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Question 8

Briefly explain how governmental loan guarantees can be valued using the option pricing model.

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Question 9

Define the term credit risk.

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Question 10

Bonds rated BBB (Baa)and above are called junk bonds.

Accepted Answer

Bonds rated BBB (Baa) and above are considered investment grade, not junk bonds. Junk bonds are typically rated below BBB (Baa) and are considered to have a higher risk of default.

Question 11

Briefly explain how the option pricing model can be used for pricing risky debt.

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Question 12

Investment-grade bonds can usually be entered at face value on the books of banks and life insurance companies.

Accepted Answer

Investment-grade bonds are considered to have a low credit risk and, therefore, are typically held by banks and insurance companies at face value on their balance sheets. Higher-risk bonds would require a discount to their face value to account for the increased risk.

Question 13

Briefly describe bond ratings.

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Quiz 23: Credit Risk and the Value of Corporate Debt