According to the committee report accompanying the Municipal Bond Fair

Question

According to the committee report accompanying the Municipal Bond Fairness Act proposed to the US Congress in 2008 (but which never became law), the cumulative historic default rates of municipal bonds (bonds issued by state and local governments) differ significantly from those of corporate bonds with equivalent credit ratings given by two prominent NRSROs (nationally recognized statistical ratings organizations), Moody's Investors Service and Standard & Poor's Rating Services (S&P). Default rates are shown as percents of all bonds ever issued in that rating category; credit ratings are shown along the horizontal axes.

Fill each blank using the drop-down menu to create the most accurate statement on the basis of the information provided.

The ratings category (as shown) that exhibits the greatest absolute difference between the municipal default rate measured by Moody's and that measured by S&P is
In a group of 540 corporate bonds, 25% of which are rated BBB and 75% of which are rated BB (both by S&P), the approximate number of bonds expected to default is

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Dropdown 1: Caa-C/CCC-C Dropdown 2: 135

Anjummm1 · Answer

Could someone please help with the solution for part 2 in this question?

Shafkat26 · Answer

Look to the right graph only for the answer.

Number of BB bonds = 540 * 75%
Default rate for BB bonds = 30%
Number of BB bonds that can default = 540 * 75% * 30% = 121.5 ~ 122

Number of BBB bonds = 540 * 25%
Default Rate for BBB bonds = 10%
Number of BBB bonds that can default = 540 * 25% * 10% = 13.5 ~ 14

Therefore total number of bonds that can default = 121.5 + 13.5 = 135

Carcass · Answer

Statement 1: Zero in on exactly what they're asking you. You're comparing Moody's and S&P, so you need to go back and forth between the left and the right graph. Next, focus on    municipal    bonds, which are represented by the solid line. The specific request is for the ratings category that exhibits the    greatest absolute difference    between the Moody's municipal line and the S&P municipal line.

This greatest difference is in the rightmost category (Caa-C/CCC-C). The Moody's municipal default rate there is about 16-17%, whereas the S&P municipal default rate there is around 45%, yielding a difference of 28-29%. Nowhere else does the difference come anywhere close to that.

The correct answer for the first blank is Caa-C/CCC-C.

Statement 2: Break this problem into parts. Focus on the BBB bonds first: 25% of 540 is 135. The S&P default rate for BBB corporate bonds is just slightly more than 10%, so you'd expect 10% of 135, or 13.5, of these bonds to default. The remaining bonds (540 - 135 = 405) are rated BB by S&P, with a 30% default rate, so 30% of 405, or 121.5, of these bonds should default. Finally, add the defaulting bonds: 13.5 + 121.5 = 135.

Alternatively, you could come up with a weighted average default rate. 25% of your bonds default at a rate of 10%, while the other 75% default at a rate of 30%. The weighted average of 10% and 30%, if weighted 25% and 75%, respectively, is 25%:

(1/4)(10) + (3/4)(30) = 25

Finally, 25% of 540 is 135.

The correct answer for the second blank is 135.

iamjatinagrawal · Answer

I got confused with the second question because in the graphs we had ratings as Baa/BBB and Ba/BB which confused a lot of my time as to what does slash represent in the graphs. But I was able to somehow have a calculated guess of the answer.

According to the committee report accompanying the Municipal Bond Fair

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According to the committee report accompanying the Municipal Bond Fair

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