Impact of Credit Downgrade on Bond Pricing

Very Hard Credit Analysis And Valuation Credit Risk Measurement

ABC Corporation has issued a 10-year bond with a face value of $1,000 and a coupon rate of 5%, payable semi-annually. Recent market turbulence has led to a downgrade of ABC Corporation's credit rating from A to B, significantly increasing its credit spread. An analysis indicates that the current yield on similar B-rated bonds is 8%. In this context, consider the impact of the credit spread adjustment on ABC Corporation's bond valuation.

Which of the following statements correctly describes the effect of the downgrade on the bond's price?

The bond's price will increase due to the higher coupon payments relative to market yields.

The bond's price will decrease as the market price adjusts to reflect the higher credit risk.

The bond's price will remain unchanged as the face value is still guaranteed.

Hint

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