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IAI Actuarial Core Principles · Economic Modelling · Simple models for credit risk

Which of the following is the most accurate statement about credit rating agency ratings of corporate bonds?

Ratings give an ordinal ranking of default risk, and lower-rated bonds generally trade at wider yield spreads over risk-free bonds. Ratings change over time, are not guarantees, and do not measure liquidity.

  1. AA lower rating implies a lower probability of default and therefore a lower required yield
  2. BRatings provide an ordinal ranking of default risk, and lower-rated bonds generally trade at higher yield spreads over risk-free bondsCorrect
  3. CRatings remain fixed throughout the life of the bond
  4. DA AAA rating guarantees that the bond will never default
  5. Ratings measure only the liquidity of the bond in the market

Explanation

Ratings rank relative creditworthiness and are revised over time. Lower ratings imply higher default risk, so investors require larger spreads. The statement about a lower rating meaning lower default probability is reversed.

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