CFA Practice Question

There are 266 practice questions for this study session.

CFA Practice Question

For high-quality bonds, investors tend to focus ______.

A. more on default probability
B. more on loss severity
C. equally on both default probability and loss severity
Correct Answer: A

This is because the default risk is low.

User Contributed Comments 7

User Comment
johntan1979 Not sure if this makes any sense... why would I focus more on the default probability of something that almost will not default?
Callie2 I thought the same thing.
HolzGe1 You only know that something "almost will not default" if you know its default probability, no? And since it's unlikely to default, it doesnt make sense to focus on loss severity.
vsimco You focus on Probability because if the probability is close to 0 i.e risk-free (its close not =), the loss severity is not an important factor in expected loss. Expected loss is what investors care about.
CJPerugini ^dafuq you say?
ascruggs92 The question does not ask what they focus on most, just what they focus on more. Given the choice of answers you know that is asking which one investors focus on more between the two.

Investors buy high quality bonds because they want minimize their chance of loss, not maximize their return. In other words, they don't focus on loss severity as much (if at all) because they are buying bonds with the expectation that they won't default. Their main focus is finding bonds with the lowest default risk.

If that still doesn't make sense, just think about the situation flipped. Investors buying high yield or junk bonds are aware of the high default risk associated with such investments, therefore they focus more on the loss severity in event of default than they do on the risk of default itself. Again, this isn't to say they ignore it all together, default risk is simply less of a focus because the risk is already implied based on the investment type.
MC1906 @ascruggs92, thank you.
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