Question

Select the true statement about default risk. It is the risk that the bond's price will fall below its par value. Bondholders have a degree of legal protection against default risk, but it is not comprehensive. Default risk relates to a bond's periodic coupon payments, but not to its maturity payment. Bondholders are guaranteed to be repaid in full if a company enters bankruptcy.

Answer 1

Answer:

Bondholders have a degree of legal protection against default risk, but it is not comprehensive.

Explanation:

A bond can be defined as a debt or fixed investment security, in which a bondholder (investor or creditor) loans an amount of money to the bond issuer (government or corporations) for a specific period of time. The bond issuer are expected to return the principal (face value) at maturity with an agreed upon interest (coupon), which are paid at fixed intervals.

The par value of a bond is its face value and it comprises of its total dollar amount as well as its maturity value. Also, the par value of a bond gives the basis on which periodic interest is paid. Thus, a bond is issued at par value when the market rate of interest is the same as the contract rate of interest. This simply means that, a bond would be issued at par (face) value when the bond's stated rated is significantly equal to the effective or market interest rate on the specific date it was issued.

In Economics, bonds could either be issued at discount or premium. A bond that is being issued at a discount has its stated rate lower than the market interest rate, on the specific date of issuance while a bond that is issued at a premium, has its stated rate higher than the market interest rate on the specific date of issuance.

Default risk in bonds refer to the risk that a bond issuer (borrower) is unable to pay the principal or interest agreed upon in the contract with the bondholder (lender) in a timely manner.

Hence, the true statement about default risk is that bondholders have a degree of legal protection against default risk, but it is not comprehensive.