Bond ratings summarize the likelihood that a bond issuer will meet its payment obligations.

a. Highly rated investment-grade bonds are those with the lowest risk of default.

b. If a firm encounters financial difficulties, its bond rating may be downgraded.

c. Commercial paper is the short-term version of a privately issued bond.

d. Junk bonds are high-risk bonds with very low ratings. Firms that have a high probability of default issue these bonds.

e. Investors demand compensation for default risk in the form of a risk premium.

The higher the risk of default, the lower a bond’s rating, the higher its risk premium, and the higher its yield.