Question #30
Reading: Reading 28 Credit Analysis Models
PDF File: Reading 28 Credit Analysis Models.pdf
Page: 12
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
Mihor Kotak is evaluating the impact of a ratings upgrade on 1Team bonds. The bonds have a modified duration of 5.88 and the current credit spread on the bonds is 60 bps. After the upgrade, Kotak expects that the spreads will narrow by 15bps. Based on Kotak's expectations, what will be the estimated change in the price of the bond if the upgrade occurs?
Answer Choices:
A. 8.82%
B. 0.38%
C. 0.88%
Explanation
Change in spread (given) = – 15 bps
Δ%P = – (modified duration of the bond) × (Δ spread) = –5.88 × –0.0015 = –0.00882 or
0.88%. Since spread narrows, price will increase (i.e., a positive price change).