Question

Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during cycle expansions and increase during recessions. Why is this so?

Answer 1

Solution:-Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during cycle expansions and increase during recessions why because During business cycle booms, fewer corporations go bankrupt and there is less default risk on corporate bonds, which lowers their risk premium. Similarly, during recessions, default risk on corporate bonds increases and their risk premium increases. The risk premium on corporate bonds is thus anticyclical, rising during recessions and falling during booms.As the economy enters an expansion, there is greater likelihood that borrowers will be able to service their debt.Risk premiums will fall in an economic expansion as business revenue and profits improve, making it easier for borrowers to make scheduled interest payments on their debt and increasing the likelihood that the business will repay the principle of that debt.