Question

1. Explain why risk premium on bonds rises in recessions and falls in economic expansion?

Answer 1

• Risk premiums on bonds rises in recessions and falls in economic expansion.
• This phenomenon of rise and fall of risk premiums on corporate bonds makes them anti - cyclical in nature.
• During economic expansion or boom, the default risk on corporate bonds is lowered as only few banks go bankrupt.
• When the risk on corporate bonds fall, th risk premiums on bonds also fall.
• While during recessions, the risk on corporate bonds increases which inturn leads to a rise in risk premium on those bonds.