FRM Part I · FRM Exam Part I · Corporate Bonds
Holding other factors constant, which change would most likely cause the credit spread on a company's existing bond to widen?
A rating downgrade most likely widens the credit spread, because it signals higher default risk and investors require extra yield. Higher recovery, lower default probability and better liquidity each reduce the compensation demanded, so they narrow spreads.
- AA rating agency downgrade of the issuerCorrect
- BAn increase in the bond's recovery rate
- CA reduction in the issuer's probability of default
- DImproved liquidity in the bond's secondary market
Explanation
A downgrade signals a higher default probability, so investors demand more compensation and spreads widen. Higher recovery, lower default probability and better liquidity all reduce the spread.
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