We would expect the relationship between the risk spread on Baa bonds and U.S. Treasury securities of similar maturities to:
A) vary directly with economic growth.
B) show no variation over the business cycle.
C) vary inversely with economic growth.
D) be uncorrelated with economic growth.

Question

Quizplus · Accepted Answer

The risk spread on Baa bonds and U.S. Treasury securities of similar maturities tends to vary inversely with economic growth. When the economy is growing, investors are more optimistic about the future and are willing to take on more risk in search of higher returns. This leads to a narrowing of the risk spread between Baa bonds and Treasuries. Conversely, when the economy is contracting or in recession, investors become more risk-averse and demand higher yields to compensate them for the increased risk of default. This leads to a widening of the risk spread.

We Would Expect the Relationship Between the Risk Spread on Baa