Bradco Bonds: Risk Change Analysis

Change in Risk of Bradco Bonds

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Question

Chris South owns $25,000 face value of Bradco bonds, which have a 7% coupon, pay interest semiannually, and have six years remaining until maturity. The bonds are callable at par. The bonds were rated A when Chris bought them at par two years ago, and they are currently worth $26,225, with a rating of AA. Which of the following statements most accurately describes the change in the risk of the Bradco bonds?

Answers

Explanations

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A. B. C.

C

Based on the information provided, we can analyze the change in the risk of the Bradco bonds as follows:

  1. Call risk: Call risk refers to the risk that a bond may be redeemed (called) by the issuer before its maturity date. In this case, the bonds are callable at par, which means the issuer has the option to redeem them at face value. The question does not provide any information regarding the callability of the bonds or any changes in their call features. Therefore, we cannot conclude anything about the change in call risk based on the given information. Hence, option A cannot be determined from the information provided.

  2. Liquidity risk: Liquidity risk refers to the risk of not being able to easily sell a security without incurring a loss. The information states that the Bradco bonds were worth $26,225, which is higher than their face value of $25,000. This suggests that the market value of the bonds has increased since Chris purchased them two years ago. An increase in market value generally indicates improved liquidity because the bonds can now be sold for a higher price, potentially with lower liquidity risk. Therefore, based on the increase in market value, we can conclude that the liquidity risk of the Bradco bonds has decreased. Thus, option B is the most accurate statement.

  3. Credit risk: Credit risk refers to the risk of the issuer defaulting on its debt obligations. The information states that the bonds were rated A when Chris bought them and are currently rated AA. An upgrade in the credit rating from A to AA indicates a decrease in credit risk. A higher credit rating suggests that the issuer's ability to fulfill its financial obligations has improved, reducing the likelihood of default. Therefore, based on the upgrade in credit rating, we can conclude that the credit risk of the Bradco bonds has decreased. Thus, option C is the most accurate statement.

To summarize, the most accurate statement regarding the change in risk of the Bradco bonds based on the given information is that the liquidity risk (option B) and the credit risk (option C) have both decreased.

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