The default risk premium fluctuates mainly
A)because bond rating agencies tend to be inconsistent in their ratings of bonds.
B)because risk-neutral investors will often become risk-averse as time passes.
C)because taxes tend to rise over the long run.
D)as new information about a borrower's creditworthiness becomes available.

Question

Quizplus · Accepted Answer

The default risk premium refers to the additional return that investors require for taking on the risk of default by a borrower. As new information about a borrower's creditworthiness becomes available, the risk of default may increase or decrease, causing the default risk premium to fluctuate. This is especially true for bonds with lower credit ratings, which are more susceptible to changes in default risk. Bond rating agencies can also play a role in influencing the default risk premium by updating their ratings based on new information. However, it is not due to inconsistency in their ratings as stated in option A. Option B is incorrect because risk-neutral investors by definition do not consider risk in their investment decisions, so changes in their risk preference would not affect the default risk premium. Option C is also incorrect because taxes do not directly impact the default risk premium, although they may affect the after-tax return received by investors.

The Default Risk Premium Fluctuates Mainly