- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 16. Credit Analysis for Corporate Issuers
- Subject 1. Assessing Corporate Creditworthiness
CFA Practice Question
If the market expects that the financial health of a bond issuer is going to deteriorate, the first warning signal is ______.
B. widened credit spread
C. higher coupon rate required by bond investors
A. downgraded credit rating
B. widened credit spread
C. higher coupon rate required by bond investors
Correct Answer: B
A widening of the credit spread of the bond will happen first, followed by the downgrade of the bond. The two usually happen long before the issuer actually defaults.
User Contributed Comments 6
| User | Comment |
|---|---|
| danlan2 | Why B happens before A? |
| PhiWong | I believe it is the expectation drove the credit spread to be widen. Any existing bond price will be depressed and yield will be widen compared to the same maturity of treasury. |
| bmeisner | Usually a downgrade happens after the market has already priced in the additional risk. Ratings guys are always behind the curve. |
| noonah | Downgrade is made after a thorough study, while credit spread is actively traded, and hence the reaction of the latter to any news is much quicker. |
| ciji | EMH all the way. |
| khalifa92 | very nice question, market expectations are deadly. |