CFA Practice Question

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CFA Practice Question

Which of the following statements is (are) true with respect to analyzing a high-yield bond issuer?

I. If the issuer is a holding company, its operating cash flows can only come from its subsidiaries.
II. The high-yield bond of an issuer would most likely have the same risk premium as the issuer's outstanding equity.
III. Traditional ratio analysis is still the best way to assess the credit risk inherent in high-yield bonds.
IV. So long as an issuer doesn't restructure and its stock price is expected to have a positive value during the high-yield bond's maturity, the high-yield bond would be deemed viable.
A. I and IV
B. II and IV
C. I, III and IV
Explanation: I is true because a holding company only collects the dividends paid from its various subsidiaries; this would not constitute operating cash flow to the parent.

II is incorrect because even though high-yield bonds are risky, they are still regarded as having a higher absolute priority over equities. Therefore, the high-yield bond of an issuer will have a lower risk premium than the issuer's outstanding equity.

III is not exactly true because the high risk nature of high-yield bonds would automatically translate into poor ratings using traditional ratio analysis. Thus, many investors rely on equity analytical tools in order to evaluate high-yield bonds.

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