Just before the collapse of the subprime mortgage market in 2007, the most important credit-rating agenciesrated mortgage-backed securities with Aaa and AAAratings. Explain how it was possible that a few monthsinto 2008, the same securities had the lowest possibleratings. Should we always trust credit-rating agencies?

“Inside the company fixed income managers bought bonds but they did not keep them for very long at all. Instead, they were constantly buying, exchanging and selling the bonds in their portfolios” Explain why the behavior described in the above quote may happen in terms of interest-rate risk immunization and downgrade risk. Do not discuss speculation or arbitrage as causes of this behavior as these will not gain any credit in this examination.

Bonds are like loans the issuers get from investors. Just as your credit worthiness is evaluated when you apply for a loan, the credit worthiness of the bond also needs to be evaluated. To do this, independent agencies have created a rating system. To help investors evaluate bonds, private rating agencies such as Moody’s and Standard & Poor’s assign grades to designate a bond’s quality. Which of the following statements regarding the rating system are correct? Check all that apply. Once a bond receives a rating, it cannot be changed.   A bond rated Ba by Moody’s is comparable to a bond rated BB by Standard & Poor’s.   Different rating systems are used for corporate versus municipal bonds.   The average yields on Aaa bonds are generally lower than the average yields on Baa bonds.   The rating C signifies a lower risk of default than a B rating.     The following chart shows the distribution of Moody’s ratings for municipal bonds between 1970 and…

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