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Chapter 6: Q.7 (page 188)

What is a key function of credit-rating agencies? Do credit-rating agencies always provide reliable information? What was the role of credit-rating agencies in the sub-prime crisis of 2008?

Short Answer

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Credit rating agencies were established to provide data to lenders, which allow them have more information about who they are giving money to. The credit-rating agencies are independent and must be accurate to maintain their reputation and trustworthiness. In the 2008 sub-prime crisis the credit-rating agencies had financial incentive to rate low quality borrowers as better than they were.

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Explanation

Credit rating agencies were established to provide data to lenders, which allow them have more information about who they are giving money to. The credit-rating agencies are independent and must be accurate to maintain their reputation and trustworthiness. In the 2008 sub-prime crisis the credit-rating agencies had financial incentive to rate low quality borrowers as better than they were.

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Most popular questions from this chapter

If bond investors decide that 30-year bonds are no longer as desirable an investment as they were previously, predict what will happen to the yield curve, assuming (a) the expectations theory of the term structure holds, and (b) the segmented markets theory of the term structure holds.

In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis. Using bond market graphs, compare the effects on the risk premium between U.S. Treasury debt and comparable-maturity Greek debt.

Following a policy meeting on March 19,2009the Federal Reserve made an announcement that it would purchase up to $300billion of longer-term Treasury securities over the following six months. What effect might this policy have on the yield curve?

During 2008, the difference in yield (the yield spread) between three-month AA-rated financial commercial paper and three-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to zero, spiking to over a full percentage point at its peak in October 2008. What explains this sudden increase?

Assuming the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to four years, and plot the resulting yield curves for the following paths of one-year interest rates over the next four years:

a. 4%, 6%, 11%, 15%

b. 3%, 5%, 13%, 15%

How would your yield curves change if people preferred shorter-term bonds to longer-term bonds?
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