Question

1. What ratings comprise investment-grade bonds and what ratings are used for junk bonds? What are the primary differences between the two? In particular, why are investment-grade bonds more marketable and why are junk bonds issued at all?

Clearly state your answer to each problem. Answers without justification/explanation will not be given credit

Answer 1

A bond is given a 'rating' that indicates its quality. A bond with a higher rating indicates that the borrower's ability to repay the interest and principal timely.

Some of the widely known rating agencies are:

-Moody's

-Standard and Poor's

-DBRS

Investment grade: Bonds having a rating of BBB- or higher are comprised in the 'Investment grade' bond. Thus bonds with ratings from AAA to BBB- are Investment grade bonds.

Junk grade: Bonds having rating of BB or lower comprise the junk bonds.

Investment grade	Junk bonds
Issued by lenders having less risk	The lenders have greater default probability
The returns offered are not very high. However, the risk of default by the lender is low.	Since the credit rating of the bond is low, hence these bonds offer higher yield. However, this higher yield comes at a greater risk of default.

Investment grade bonds have lower required returns than junk bonds.Investment grade bonds are more marketable because many institutions are only allowed to hold either only a small amount of junk bonds, or no junk bonds at all.

Investment grade bonds are issued by companies having good credit rating and thus these bonds carry a lower risk of default. Therefore a large of investors who are looking for reasonable safety of repayment find these bonds more compelling than junk grade bonds. Thus these bonds are more marketable. Also, as a statutory requirement, many institutions are allowed to hold only small percentage of junk bonds. It also contributes to investment grade bonds being more marketable.

Junk bonds are typically issued when the borrower has no other option left to raise finance. These are issued by companies having questionable credit rating. Thus, the borrower is compelled to pay higher returns in exchange of raising finance via debt. Junk bonds are also used to finance hostile take-overs.

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