Bond ratings are a measure of a firm's default risk

Question

BlackTom AI · Accepted Answer

The question presents the statement about bond ratings and asks us to consider its correctness.

Point to consider: bond ratings are issued by credit rating agencies to assess the creditworthiness of an issuer or a specific debt instrument. In practical terms, this assessment is primarily a proxy for default risk—the risk that the issuer will fail to make required payments of interest or principal.

Reasoning about the statement itself: 
- Bond ratings reflect the likelihood of default; a higher rating corresponds to a lower probability of default, while a lower rating signals higher default risk. This makes the core purpose of ratings to quantify default risk for investors. 
- Ratings synthesize many factors that influence default risk, such as the issuer’s leverage, cash flow, business environment, diversification, and overall financial health. This demonstrates why ratings are linked to default risk rather than to some other, unrelated measure.

About potential misconceptions one might consider: 
- Some might think ratings measure market liquidity or price volatility. While ratings can influence funding costs and perceived risk, they are not primarily a measure of liquidity or volatility; those are separate considerations. 
- Another possible incorrect thought is that ratings capture only current profitability. In fact, ratings emphasize the probability of default over a given horizon, which integrates solvency and resilience under stress, not just profitability.

Given the statement in the query, and understanding how credit ratings are used in practice, the core idea that bond ratings are a measure of default risk is conceptually sound.

Note: The provided data lists the answer as 'default risk' and includes no other answer choices to compare against, so this analysis focuses on validating the given assertion and clarifying common related misconceptions.

COMM_V 298 201-207 2024W2 Class 7: Bond Valuation Part 1 Practice Quiz

Bond ratings are a measure of a firm's default risk

View Explanation

Log in for full answers

Similar Questions

Indicate which of the following statements about credit risk is (are) false:

Which method(s) is Not used to limit exposure to credit risk?

Indicate which of the following statements about credit risk is (are) false:

Credit migration analysis:

What is credit risk (default risk)?

Which of the following is a borrower-specific factor in qualitative credit risk models?

Migration analysis primarily helps banks:

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler