- CFA Exams
- CFA Level I Exam
- Study Session 15. Fixed Income (2)
- Reading 46. Understanding Fixed-Income Risk and Return
- Subject 8. Credit and Liquidity Risk
CFA Practice Question
The economy is projected to emerge from a recession soon. The spread between AAA and CAA rated bonds can be expected to ______.
A. diminish
B. increase
C. diminish and increase later as the economy rebounds
Explanation: As the economy expands, the risk of default due to improving cash flows would diminish and reduce the spread between higher-rated and lower-rated bonds.
User Contributed Comments 3
| User | Comment |
|---|---|
| shiva5555 | Does this mean the price or the return? I thought as the economy improves more people buy junk bonds. |
| poomie83 | the riskier the bond the higher the yield required and lower the price. Although bonds maybe junk their risk of default is low in boom times and this narrows the yield spread between A grade and junk. |
| lighty0770 | Think about yield movements relative to the economic cycle. During a recession, junk bonds need to have higher yields given their relative risk (i.e. AIG during 2009), but when we emerged from the recession the spreads tightened as the companies issuing junk bonds were not in as bad as a financial spot and therefore yield spread closed |