Why do investors pay attention to bond ratings and demand a higher interest rate for bonds with low ratings?

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Why do investors pay attention to bond ratings and demand a higher interest rate for bonds with low ratings?



Answer: Investors demand higher promised yields if there is a high probability that the borrower will run into trouble and default. CREDIT RISK implies that the promised yield to maturity on the bond is higher than the expected yield. The additional yield investors require for bearing credit risk is called the DEFAULT PREMIUM. Bond ratings measure the bond's credit risk.

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