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Rating Migration and Fallen Angels

Separate deteriorating credit from mandate-driven flows and assess the spread on downgraded bonds.

These prompts are original practice. They are not questions from a named employer or a live hiring loop.

The index exit

A $500m bond drops from BBB− to BB+. The hypothetical index deletes it at month-end. Index trackers own $90m, other mandate sellers own $45m with no overlap, and dealers estimate $30m of daily capacity.

  1. 1.What fraction do trackers hold?

  2. 2.What face might both groups sell?

  3. 3.What fraction of issue is that?

  4. 4.What minimum whole days does it take at that capacity?

  5. 5.If capacity halves, how many days are needed?

  6. 6.What date can concentrate tracker trading?

  7. 7.Why verify ownership overlap?

  8. 8.What could mitigate price pressure?

  9. 9.Does deletion itself change promised principal?

  10. 10.What separates technical pressure from credit deterioration?

Spread shock

A note yields 5% at 180 bp spread. Its benchmark yield is unchanged after downgrade and spread reaches 310 bp. Spread duration is 4.5. Ignore convexity.

  1. 11.What is benchmark yield?

  2. 12.How far did spread widen?

  3. 13.What is post-event yield?

  4. 14.Estimate spread price change.

  5. 15.If spread retraces 40 bp, what price gain follows locally?

  6. 16.What does static duration miss on a large move?

  7. 17.What if rates also fall with unchanged duration of 4?

  8. 18.Why also check issue-specific quotes?

  9. 19.What supports a flow-driven retracement thesis?

  10. 20.What is useful in the memo?

Expected loss screen

A senior bond offers 420 bp. A one-year screen assumes 4% default probability and 45% recovery on par. Liquidity and risk premia are separate.

  1. 21.What is loss given default?

  2. 22.What is simplified expected loss?

  3. 23.What spread remains after that loss?

  4. 24.If probability rises to 7%, what is expected loss?

  5. 25.What pickup remains at that probability?

  6. 26.What probability consumes the whole spread at the original recovery?

  7. 27.Why is the initial 200 bp not certain excess return?

  8. 28.If recovery slips to 30% with 4% default odds, what expected loss follows?

  9. 29.What should a distressed purchase below par use for investment loss severity?

  10. 30.How should this screen be used?

Split ratings

A bond is rated BBB− at agency X, BB+ at Y, and BBB at Z. Fund A requires all three investment grade. Fund B requires two. Fund C uses X only. Hypothetical mandates take effect immediately.

  1. 31.Which funds can hold initially?

  2. 32.If X drops to BB+, who can still hold under those rules?

  3. 33.If Y alone upgrades to BBB− from the initial state, what changes?

  4. 34.If Z alone falls to BB+ from the initial state, who remains eligible?

  5. 35.Why read the actual mandate?

  6. 36.Is negative outlook the same as a downgrade?

  7. 37.What should a calendar include?

  8. 38.What if a mandate allows a grace period?

  9. 39.What is a useful check on fund holdings?

  10. 40.How should an analyst present uncertain eligibility?

Rating trigger

A borrower has $480m net debt and $120m EBITDA. A model flags downgrade risk above 4.5×. EBITDA may fall to $100m. A disposal can generate $40m net cash for repayment.

  1. 41.What is initial leverage?

  2. 42.What leverage follows the EBITDA shock alone?

  3. 43.What leverage follows the sale and paydown in stress?

  4. 44.Minimum paydown to reach exactly 4.5× in stress?

  5. 45.If sale closes three months after review, can it be counted as done?

  6. 46.What if the disposal also removes $10m EBITDA from the stressed base?

  7. 47.Why treat 4.5× as a screen?

  8. 48.What evidence supports a durable improvement?

  9. 49.What contract item can worsen the forecast on downgrade?

  10. 50.What should the risk memo say first?

Diverging bonds

A firm has a short secured bond and a long unsecured bond. Both migrate to high yield. Stressed recovery per 100 face is 80 and 45 respectively. Quotes are 95 and 75. Ignore coupons for default loss.

  1. 51.What loss points does the secured bond face at recovery?

  2. 52.What loss points does the unsecured bond face?

  3. 53.What percentage of invested cost does secured lose?

  4. 54.What percentage of invested cost does unsecured lose?

  5. 55.Which has smaller modeled loss severity?

  6. 56.What can make the long bond more volatile before default?

  7. 57.Why compare trading pressure separately by issue?

  8. 58.What if the secured collateral declines materially?

  9. 59.What evidence could make the longer issue attractive?

  10. 60.What if bond documents permit more senior borrowing?

Tender after migration

A downgraded issuer has $200m due in 12 months and $140m usable cash. It tenders for $80m face at 93 using existing cash. A $5m fee applies. Ignore other changes.

  1. 61.What cash does the tender pay to bondholders?

  2. 62.What total cash outflow occurs at tender?

  3. 63.What principal remains due?

  4. 64.What usable cash remains?

  5. 65.What gap remains at maturity?

  6. 66.How much does the tender improve the funding gap?

  7. 67.Why can a below-par tender deliver little benefit?

  8. 68.What if the tender uses restricted cash that cannot fund the maturity otherwise?

  9. 69.Which holder still needs a maturity analysis?

  10. 70.What should a memo compare alongside the tender?

Technical dislocation

A comparable bond trades at 350 bp. The fallen angel trades at 480 bp. The desk estimates 35 bp of incremental expected loss and 45 bp of liquidity cost on a common horizon.

  1. 71.What gross pickup is observed?

  2. 72.What pickup remains after both deductions?

  3. 73.If desk requires 60 bp residual, does it pass?

  4. 74.At unchanged adjustments, what spread passes exactly?

  5. 75.If liquidity cost drops to 25 bp, what residual follows at 480?

  6. 76.Why match duration and rank in the comparable?

  7. 77.What evidence shows liquidity improving?

  8. 78.What could invalidate the technical thesis?

  9. 79.Why set an entry limit?

  10. 80.What should remain in the bear case?

Downgrade-dependent funding

An issuer has $100m floating debt at 6%. A downgrade raises its spread by 150 bp. A separate bond of $200m requires 75 bp more at refinancing. Assume no tax effects.

  1. 81.What is annual interest on the floating debt before downgrade?

  2. 82.What extra annual cost does the floating step create?

  3. 83.What annual increase follows on the new bond?

  4. 84.What combined annual increase occurs after both are in effect?

  5. 85.If prior free cash flow was $10m, what is it after the increase alone?

  6. 86.Why include an access-closed case too?

  7. 87.What timing should be applied to interest changes?

  8. 88.What else might activate when ratings fall?

  9. 89.What protects against a mistaken causal story?

  10. 90.What should the next review track?

Re-entry thesis

An eligible high-yield buyer considers a 96 executable purchase price versus outcomes of 104 on recovery, 94 if pressure persists, and 70 if credit weakens. Probabilities are 45%, 45%, 10%. Ignore coupons and costs initially.

  1. 91.What expected exit price follows?

  2. 92.What gross expected gain per 100 face follows?

  3. 93.With 0.50 of round-trip costs, what expected payoff remains?

  4. 94.What entry price breaks even with those costs?

  5. 95.If 10 points of probability shift from persistence to recovery, what happens to expected exit?

  6. 96.What is the worst stated mark loss before costs?

  7. 97.What if a mandate cannot hold this bond?

  8. 98.What test should precede any purchase?

  9. 99.What would warrant resizing after entry?

  10. 100.What should the post-review distinguish?

  11. 101.What evidence would strengthen the proposed catalyst?