Question

Based on your understanding of bond ratings and bond-rating criteria, which of the following statements is true? During an economic recession and in a pessimistic environment, the yield spread between US government bonds and corporate bonds could be higher than during good economic times. During a period of economic growth and in an optimistic environment, the yield spread between US government bonds and corporate bonds could be higher than during an economic recession and a pessimistic environment.

Answer 1

Answer:

The correct answer is option a.

Explanation:

If the economy entered a recession, then the chances of a firm defaulting on its bond would rise. As a result, its Yield to maturity would increase.

The yield spread between a corporate bond and a Treasury bond with the same maturity is an indicator of investors’ risk aversion as well as their attitude regarding the economy and corporate profits (optimism/pessimism).

In case the economy appeared to be moving towards a recession, this spread should widen. This change in spread would be even more in case credit strength of a firm is weakened.