An increase in the riskiness of corporate bonds will ________ the yield on corporate bondsand ________ the yield on Treasury securities, everything else held constant.A) increase; increaseB) reduce; reduceC) increase; reduceD) reduce; increase
Question
An increase in the riskiness of corporate bonds will ________ the yield on corporate bondsand ________ the yield on Treasury securities, everything else held constant.A) increase; increaseB) reduce; reduceC) increase; reduceD) reduce; increase
Solution
The correct answer is C) increase; reduce.
Here's why:
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An increase in the riskiness of corporate bonds makes them less attractive to investors, unless the yield (or return) on these bonds also increases. Therefore, the yield on corporate bonds will increase.
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When corporate bonds become riskier, investors will look for safer investments. Treasury securities are considered to be one of the safest investments because they are backed by the U.S. government. Therefore, the demand for Treasury securities will increase.
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When the demand for an asset increases, its price also increases. The yield, or return, on an asset is inversely related to its price. Therefore, as the price of Treasury securities increases, their yield will reduce.
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