CFA Level I · CFA Level I Exam · Credit Analysis for Government Issuers
A credit rating agency downgrades a sovereign from BBB to BB, moving it below investment grade. The most likely consequence for the sovereign's bonds is:
Forced selling by investors restricted to investment-grade holdings is most likely. Many mandates prohibit holding sub-investment-grade debt, so a downgrade to BB triggers sales, lowering bond prices and widening spreads. It does not change principal owed, and demand would not rise.
- Aa lower yield spread as demand from investors rises
- Bforced selling by investors restricted to investment-grade holdingsCorrect
- Can automatic reduction in outstanding principal
Explanation
Many institutional investors have mandates limiting holdings to investment-grade debt, so a fall below BBB- can trigger forced selling, pushing prices down and spreads up. Ratings do not alter principal, and spreads widen rather than narrow.
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