Question

Which of the following is true?

A. During an economic recession and in a pessimistic environment, the yield spread beteen US government bonds and corporate bonds could be higher than during good economic times.

B. During a period of economic growth and in an optimistic environmrnt, the yield spread between US government bonds and corporate bonds could be higher than during an economic recession and a pessimistic environment

Answer 1

(A).True.

If the economy entered a recession, then the possibility of a firm defaulting on its bond would increase; consequently, its YTM would increase. The yield spread between a corporate bond over a Treasury bond with the same maturity reflects both investors’ risk aversion and their optimism or pessimism regarding the economy and corporate profits. If the economy appeared to be heading into a recession, the spread should widen. The change in spread would be even wider if a firm’s credit strength weakened.

(B).False.

The credit default of corporate bonds reduce and provide higher interest rate than the treasury bonds but selling at higher rates. The yield spread is narrow in case of growth since the investors move there investments to lower quality, high risk bonds from higher quality corporate bonds or treasuries