NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Investing in Fixed Income Securities (NISM XXI-A)
Which of the following risks is MOST directly associated with a corporate bond being downgraded by a credit rating agency, leading to widening of its spread over government securities?
Credit risk is the risk involved. A rating downgrade signals greater chance of the issuer failing to pay interest or principal, so investors demand a higher spread over government securities, which lowers the bond's price.
- AReinvestment risk
- BCredit riskCorrect
- CInflation risk
- DCall risk
Explanation
A downgrade signals higher probability of default or lower repayment capacity, which is credit risk. Investors demand a higher spread, so the price falls. Reinvestment, inflation and call risks relate to cash flow reinvestment, purchasing power and early redemption respectively.
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