Question

There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower. a. True b. False

Answer 1

Answer:

a. True

Explanation:

Bond rating is a method used to convey the creditworthiness and quality of bonds. The rating system uses letters and AAA rating is considered to be the best rating.

The better the rating of a bond, the safer the investor would be considering the invested funds. The better the rating, more the assurance of bond making timely coupon payments and repayment.

When a bond is not well rated, the investor would be at a risk while investing in such a bond. In such cases, the investor would only invest if he is compensated for this extra risk assumed by higher expected rate of coupon payments i.e YTM( yield to maturity).

Thus, an investor would expect higher required rate of return from a BB rated bond than a AA rated bond.