In mid-September, 2015 S&P 500 lowered the credit rating of We$ellDrugs, Inc (W$D) from AAA to AA in response to widespread outcry about the pricing of generic drugs that were recently purchased by the company. In a statement, S&P noted that lower generic prices call into question the ability of W$D ability to meet their coupon payments. W$D’s rating had been at AAA since January 2005 prior to the recent change.
a. What do you expect to happen to the price of W$D’s outstanding bonds?
b. W$D’s competitor, Healthy Lives for All, Inc (HLA) has had a credit rating of AA for the last 11 years. If the coupon on W$D’s 10 year bonds issued on October 1, 2008 is 7% what would you expect the coupon to be higher or lower on Healthy Lives for All’s 10 year bonds also issued on October 1, 2008?
c. How would the yield to maturity of the W$D and HLA bonds compare today (October, 2015) ?
d. What would happen to the yield of the W$D bonds if the Federal Reserve surprisingly announced a half-point increase in its interest rate charged to banks?
e. The market mechanism that underlies your answer in part D can be described in several steps. What are those steps? Use the hints below to complete your answer.
Hint:
Step 1: Fed increases its rate the Required Return on Debt increases
Step 2: Then investors (buy/sell) …….
Step 3: The price of goes (up/down) until ….
Step 4: The yield then ….