If the probability of a bond default increases because corporations begin to suffer large losses,then the default risk on corporate bonds will ________ and the expected return on these bonds will ________,everything else held constant.
A)decrease;increase
B)decrease;decrease
C)increase;increase
D)increase;decrease

Question

Quizplus · Accepted Answer

As the probability of default on corporate bonds increases due to large losses suffered by corporations, investors demand a higher return to compensate for the increased risk. Therefore, the expected return on corporate bonds will decrease. However, the increased default risk makes these bonds less attractive, which reduces demand and ultimately results in a drop in bond prices. As bond prices fall, the yield on these bonds increases, thereby increasing the expected return on corporate bonds. Hence, the default risk on corporate bonds will increase, and the expected return on these bonds will decrease.

If the Probability of a Bond Default Increases Because Corporations