An investor holds speculative-grade corporate bonds issued by a commercial satellite communications firm. Following a launch vehicle failure that destroyed the company's flagship satellite payload, credit rating agencies downgraded the issuer's debt from BBB- to B+ due to heightened cash flow and default concerns. Simultaneously, the Federal Reserve increased benchmark interest rates by 50 basis points to mitigate broad inflationary pressures. Which of the following statements regarding the risks present in this scenario are correct?
- The credit rating downgrade following the operational failure exemplifies credit risk, which is a non-systematic risk tied to the issuer's financial stability.Answer
- The revenue impairment caused by the satellite payload loss represents business risk, a non-systematic risk that can be reduced through portfolio diversification.Answer
- CThe bond price drop caused by the Federal Reserve's rate hike represents non-systematic credit risk that uniquely impacts corporate bondholders.
- DThe market value loss stemming from the interest rate increase is a systematic risk that can be fully eliminated by spreading investments across multiple corporate bond issuers.
Answer
The correct statements are that the rating downgrade exemplifies non-systematic credit risk, and the operational revenue impairment represents business risk, which can be mitigated through asset diversification.
The satellite destruction and subsequent debt downgrade are firm-specific events that illustrate business risk and credit risk, respectively. Both are non-systematic risks that can be mitigated by holding a diversified portfolio of securities across different industries.
Step-by-Step Solution
Key Concept
Non-Systematic vs. Systematic Risk and Credit/Business Risk Identification
Estimated Time:2m 0s