Question

the prevailing yield on a B-rated corporate bond in 7 percent. explain how the yield offered on new B-rated bonds could be affected if economic conditions deteriorate. there are two forces that deserve consideration?

Answer 1

A bond yield is affected by market conditions. If the economic conditions deteriorate, investors demand a higher return for the same bond, as they have to be compensated for a higher risk now, and hence will be offered higher yield. In short, the chances of a default goes higher in case of a deteriorated economic event. Also, the deteriorating economic conditions can cause a decline in the demand for credit funds. Due to the decline in demand of loans in the economy, the risk-free rate might decline. But the overall sentiment deteriorates and hence investors demand a higher than 7 percent yield on the same B-rated corporate bond.