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Question

Difficulty: EasyNon-Systematic and Credit Risks

An investor holding corporate debt issued by a biotech firm learns that credit rating agencies have downgraded the issuer's debt rating from investment grade to speculative grade following poor clinical trial results. Which of the following risks has primarily heightened for this investor?

  1. Credit riskAnswer
  2. B
    Interest rate risk
  3. C
    Purchasing power risk
  4. D
    Market risk

Answer

Credit risk (or default risk) is the primary risk heightened when an issuer receives a credit rating downgrade.
Credit risk represents the possibility that a borrower will default on interest or principal obligations. When credit rating agencies downgrade a firm's debt due to operational difficulties, the probability of default increases, directly elevating the credit risk for bondholders.

Step-by-Step Solution

1
Analyze the event described in the scenario
The corporate bond issuer's credit rating was downgraded from investment grade to speculative grade due to adverse company-specific events.
Credit ratings measure the financial capacity of an issuer to honor scheduled debt obligations.
2
Classify the specific risk type associated with credit rating changes
A rating downgrade directly reflects an increased probability of default or failure to make timely debt service payments, which defines credit risk.
Credit risk is a non-systematic risk tied to the issuer's financial health, distinct from market-wide macroeconomic risks.

Key Concept

Credit Risk and Rating Downgrades
Estimated Time:45s
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Topics

Non-Systematic and Credit Risks

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