Question

BurgerSupreme started as a business in 2010. The necessary capital was raised by issuing bonds. Over the last 5 years all major competitors have made more money for their investors than BurgerSupreme has.  Sales at its restaurants have been falling for the last three consecutive years, the price of its shares have lost more than 50% of their value, BurgerSupreme’s debt ratio is increasing, and sales projections for the next 12 months look very weak. The typical BurgerSupreme outlet has 50% higher annual costs in wasted food than a comparable outlet from the competition and its utility and maintenance costs are at least 25% higher.

Which of the following statements about BurgerSupreme's bonds is true?

	a.	BurgerSupreme bonds today are most likely trading at par
	b.	BurgerSupreme's bonds today are most likely trading below par
	c.	BurgerSupreme bonds today are most likely trading above par

Answer 1

Bond prices and bond yields are inversely related. Higher the bond yield, lower the bond price and lower the bond yield, higher the bond price. A bond with a yield higher than its coupon rate is priced below par, and a bond with a yield lower than its coupon rate is priced above par.

The yield of a bond and the risk of the bond are directly related. Higher a bond's risk, higher its yield. This is because investors require a higher return for investing in bonds with higher risk.

The bonds of BurgerSupreme are of high risk because the business is performing very poorly. It is uncertain if BurgerSupreme can continue to service its debt obligations on time.

Due to the high risk, the bonds would be trading at high yields. This means that the bonds are most likley trading below par.

The answer is (b)