BASIC SPREAD Q therefore, quality, between, require

JustasS

If investors expect greater uncertainty in the bond markets, you should see yield spreads between AAA and B rates bonds:

A) slope downward.

B) narrow.

C) widen.

Answer is....C

My logic, and it may be wrong is, flight to quality. You will sell the lower yielding bonds, causing their prices to go down and their yields to go up. BUY the higher yielding bonds, causing their prices to go up and yields down, therefore NARROWING...

"With greater uncertainty, investors require a higher return for taking on more risk. Therefore credit spreads will widen."

It says spreads, not credit spreads? Or is that to be assumed....Is this question poorly worded or am i not understanding??

mnieman

the flight to quality logic is correct, although your interpretation is wrong.

for a start, aaa bond yields will be lower than b rated bonds.

when flight to quality happens, investors buy more of the less risky (aaa) bond, price rises, aaa yield falls. in other words, you will buy the lower yielding (aaa) bond and not sell it as you mentioned.

similarly, investors sell the riskier (b) bond, price falls, yield rises

hence the spread widens

dotamasta

oz001 Wrote:
-------------------------------------------------------
> the flight to quality logic is correct, although
> your interpretation is wrong.
>
> for a start, aaa bond yields will be lower than b
> rated bonds.
>
> when flight to quality happens, investors buy more
> of the less risky (aaa) bond, price rises, aaa
> yield falls. in other words, you will buy the
> lower yielding (aaa) bond and not sell it as you
> mentioned.
>
> similarly, investors sell the riskier (b) bond,
> price falls, yield rises
>
> hence the spread widens

correct.