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Returns and Bond Ratings

Student’s Name

Institution Affiliation

Course

Professor

Date
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PART A.

From the data given;

Future Value (FV) = $11,000,000.00

Quoted Annual Interest Rate (r) = 9%

Number of Installments/Periods = 26

The Future Value Formula is given as:

FV = (1 + r) * P {(1 + r)n -1)/r}

“P” presents the Periodic Payment,

Therefore, P equals,

$11,000,000 = (1+0.09) * P {(1.09)26 -1)/0.09}

$11,000,000 = 1.09 * P *93.324

$11,000,000 = 101.723P

Divide both sides by 101.723

Thus, P= $11,000,000/101.723

P= $108,136.80

Periodic Payment = $108,136.80

Present Value Formula is given as:

PV = P * {(1 - (1 + r)-n)/r} * (1 + r)

PV = $108,136.80 * {(1 - (1 + 0.09)-26)/0.09} * (1 + 0.09)

PV = $108,136.80 * 9.9290 * 1.09 = $1,170,322.41

Present Value = $1,170,322.41

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PART B.

Introduction

Government agencies or private corporations may be entitled to issue bonds to the public.

However, before issuing these Bonds, one or the three main rating agencies (i.e. Moody’s, Standard

& Poor’s and Flitch) will have to assign a credit rating (Ederington, 2020). Thus, helping in

processing bonds. Bond ratings established by these agents must consider factors such as future

prospects and strengths of the issuer’s finances. Through credit ratings, investors are able to make

assessments on the likelihood of default of those bonds. However, these agencies have created

different types of bond ratings but this paper will discuss only the four main types.

AAA Rating

The AAA Rating is the highest credit rating given to a country, agency or corporation.

When Bonds under this category of credit rating, shows that their position is extremely strong and

might not be able to meet financial commitments. However, it is not guaranteed that the bond

issuer will default his responsibility to repay. The probability is very small thus making it easier for

the borrower to secure loans or the issuance of bonds are lower rate.

HK Baker (2017), bonds in this rating are considered investment grade, the offset of the

high rating is that as the risk is relatively low, then the interest that they pay to investors is not as

high
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BBB Ratings:

Bonds under this category are also long-term bonds whose investment grade is of

lower medium grade. The issuer of these bonds has sufficient financial capacity to pay its

financial responsibilities. However, in case, the economy deteriorate or other changing

situations, the issuers of these bonds have a higher default risk (Jeremy C. Goh, 2021). Bonds

in this type of rating have more returns compared to those in AAA ratings.

CCC ratings:

Bonds ‘Triple C’ rating are not considered as investment grade and are highly

speculative although they are also long-term bonds. The bonds categorized under this rating

have a higher default risk. Nevertheless, few investors may consider them as rewarding market

especially when winners are chosen. Investment volatility is very high in these types of bonds.

D Ratings:

The D ratings bonds are under corporate bonds that have higher return and higher risk.

The three main agencies have considered these bonds as “Not investment grade”. These

companies may have defaulted to meet their financial commitments at some point of their

financial life. Investors that look at these type of bonds should be very diversified and ready to

take a lost in exchange for the possibility of a higher rate of return (Wakeman, 2019).

Conclusion

Bonds rated between BBB and AAA are considered investment grade bonds. Bonds rated

BB or lower are considered speculative, high-yield, or junk bonds. Higher rated bonds are

believed to be at a lower risk of defaulting (HK Baker, 2017).

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References

Ederington, (2020) “The Bond Rating Process.” In Handbook of Financial Markets and

Institutions, 6th Ed.

Jeremy C. Goh, (2021) Bond Rating Agencies and Stock Analysts.

Wakeman, (2019) Bond Rating Agencies and the Capital Markets.

HK Baker, (2017) Assessing Credit Rating Agencies by Bond Issuers and Institutional Investors.