1.12 [Related to the Apply the Concept: “Do Credit Rating Agencies Have a Conflict of Interest?”] According to an article in the Wall Street Journal, “Investors are skeptical of some of the [bond] ratings. More than $100 billion worth of bonds trade with yields like junk despite their triple-B-minus ratings.”
1. What is a junk bond?
2. From an investor’s point of view, what is the difference between buying a bond with a BBB– rating and a junk bond?
3. Draw a demand and supply graph showing the demand curve for these bonds. Show the equilibrium price for these bonds, assuming that bond investors believed the rating agencies’ rating and the actual equilibrium price, given that investors are skeptical of the rating. Be sure to show on your graph any shifts in the demand curve or the supply curve that would explain the difference between these two prices.
4. Is the situation described in this article due just to a difference of opinion between rating agencies and investors about the creditworthiness of the firms issuing these bonds? Might there be another reason the rating agencies and investors have come to different conclusions about these bonds?
