Investment Grade

A corporate bond rated BBB-/Baa3 or higher is considered:

1. A.High-yield (junk)This is off by exactly one notch. BBB-/Baa3 is the lowest rung that still counts as investment grade, and high-yield begins immediately below it.
2. B.Investment gradeCorrect - the investment-grade cutoff.
3. C.DefaultDefault is a description of an issuer that has actually failed to pay, sitting at the bottom of the rating scale. It is an event, not the label attached to a bond meeting a quality threshold.
4. D.UnratedThe stem supplies the rating, so the bond is by definition rated. Unrated describes paper the agencies have not evaluated, which is a separate category from any grade on the scale.

Why: Ratings of BBB-/Baa3 and above are investment grade; below that is high-yield (junk).

Short-term municipal NOTES - tax anticipation notes, revenue anticipation notes and bond anticipation notes - are rated by Moody's on a scale separate from its long-term bond scale. A note carrying the highest designation on that short-term scale, MIG 1, indicates:

1. A.A credit standing equivalent to the long-term Baa category, the lowest rung of investment grade.Wrong. MIG 1 is the HIGHEST short-term designation, not the lowest investment grade rung.
2. B.That the note carries insurance from a municipal bond insurer.Wrong. Insurance is a credit enhancement that may raise a rating, but the rating symbol itself does not tell you an issue is insured.
3. C.That interest on the note is exempt from federal income tax and from the income tax of every state.Wrong. A rating measures credit quality only. Tax treatment depends on the issue and the holder's state of residence, not on the rating.
4. D.The strongest credit quality among short-term municipal notes, reflecting superior liquidity and a well-established source of repayment.Correct. MIG 1 is the top of Moody's short-term municipal note scale, which runs MIG 1 through MIG 3 with SG for speculative grade.

Why: MIG stands for Moody's Investment Grade, and the scale runs MIG 1, MIG 2 and MIG 3, with SG denoting speculative grade. It is used specifically for short-term municipal notes, where the analysis centres on near-term liquidity and the reliability of the anticipated repayment source rather than on decades of debt service capacity. MIG 1 signals the strongest credit quality: superior liquidity together with a well-established source of repayment, such as taxes already levied or a bond issue already authorised. Standard and Poor's rates the same instruments SP-1, SP-2 and SP-3.

Which of the following is the lowest rating that is still considered investment grade by the major rating agencies?

1. A.BBB minus, or Baa3 at Moody'sCorrect. This is the lowest rung of investment grade.
2. B.BB plus, or Ba1 at Moody'sThis is one notch too low. BB plus is the highest speculative-grade rating, sitting just under the line.
3. C.B, or B2 at Moody'sA single-B rating is squarely speculative grade, several notches beneath the investment-grade boundary.
4. D.A minus, or A3 at Moody'sThis is comfortably inside investment grade but is not the floor. Three full rating categories sit below it and are still investment grade.

Why: The investment-grade floor is BBB minus at Standard and Poor's and Fitch, and Baa3 at Moody's. Anything below that line is speculative grade, commonly called high yield or junk.

A client holds bonds of a company that was just downgraded from investment grade to speculative grade, and the bonds fall sharply in price. The primary risk realized here is:

1. A.Inflation riskPurchasing power is unrelated to a ratings downgrade.
2. B.Prepayment riskPrepayment applies to mortgage-backed securities, not corporate downgrades.
3. C.Interest-rate riskThe decline stems from the issuer's creditworthiness, not from a change in the rate environment.
4. D.Credit (default) riskCorrect. A downgrade reflects a deteriorating ability to pay, and prices adjust accordingly.

Why: A downgrade signals deteriorating ability to pay, so investors demand a higher yield and the price falls. This is credit (default) risk, which is issuer-specific.