Risk premiums on corporate bonds tend to ________ during business cycle expansions and________ during recessions, everything else held constant.A) increase; increaseB) increase; decreaseC) decrease; increaseD) decrease; decrease
Question
Risk premiums on corporate bonds tend to ________ during business cycle expansions and________ during recessions, everything else held constant.A) increase; increaseB) increase; decreaseC) decrease; increaseD) decrease; decrease
Solution
The correct answer is C) decrease; increase.
Here's why:
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During business cycle expansions, the economy is doing well. Companies are generally more profitable and less likely to default on their debts. This reduces the risk associated with corporate bonds, leading to a decrease in risk premiums.
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Conversely, during recessions, the economy is doing poorly. Companies are less profitable and more likely to default on their debts. This increases the risk associated with corporate bonds, leading to an increase in risk premiums.
So, risk premiums on corporate bonds tend to decrease during business cycle expansions and increase during recessions, everything else held constant.
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