When the growth rate of the economy slows we would expect:
A) the risk to increase for U.S. Treasury securities.
B) the risk spread to increase more between U.S. Treasury Securities and Aaa securities than between Aaa and Baa securities.
C) the risk spread to increase more between Aaa and Baa securities than U.S. Treasuries and Aaa securities.
D) investors to purchase more junk bonds in search of a higher yield.

Question

Quizplus · Accepted Answer

When the economy slows down, there is typically an increase in credit risk, which leads to a wider spread between the yields on higher-rated securities, such as Aaa, and lower-rated securities, such as Baa. As a result, we would expect the risk spread to increase more between Aaa and Baa securities than between U.S. Treasuries and Aaa securities. Option A is incorrect because when economic growth slows, investors often turn to safe-haven assets like U.S. Treasuries, which can lead to a decrease in their yields. Option B is incorrect because, while the spread between U.S. Treasuries and Aaa securities may widen, the spread between Aaa and Baa securities is typically more affected by changes in credit risk. Option D is incorrect because junk bonds tend to be riskier and therefore more affected by economic slowdowns, so investors may actually shy away from them in favor of safer securities.

When the Growth Rate of the Economy Slows We Would