What's the logic here?

CFA Level I Fixed Income
#1

In Practice Problems No.20 on Reading 56: Fundamentals of Credit Analysis:

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Why？

Why because default risk is quite low, so we need to focus more on default risk?

Thanks

#2

The answer is correct, but the explanation looks wrong. Since they already have a lot of debt in their capital structure, creditors would be worried if the company can make the required interest and principal payments.

#3

Loss Severity is only when there is Default. So if Default is low then Loss Severity is even Lower (you will only lose GIVEN there is default).

(As there’s high amount of publicly traded debt option C is never the option)

Hope this helps.

#4

This isn’t true.

If the probability of default is 2% the severity can be 80% (i.e., if they default, you’ll lose 4/5 of the value of the bond). You seem to be thinking that in this case the severity would be 1.6% (= 80% × 2%). That’s not the severity; it’s the 80% number.

#5

I meant in probability terms. Like you just mentioned the word “if”… that makes it conditional. Meaning if the 2% happens then only 80% will happen.

#6

But what does “high-quality debt issuer” imply? Does it imply that the default risk is low, so you do not have to concern about it?