Question

Which of the following situations would require an increase in the coupon rate for a bond selling at par? Select one: The addition of a tax exemption The addition of a convertibility option The decrease in the rating from AA to BBB The addition of sinking fund provision All of these choices are correct.

Answer 1

Investors required higher returns for investing in bonds with higher risk. Thus, if any situation increases the bond risk, the coupon rate would have to be increased in order to attract investors to invest in the bond.  

The correct answer is - The decrease in the rating from AA to BBB. As the bond rating has decreased, the bond has higher risk. Hence, a higher coupon would have to be paid.

The remaining options are incorrect. They decrease the bond risk, hence an increased coupon rate is not required.