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Question:
Recent economic data suggest an increasing likelihood that the economy will soon enter a recessionary phase. What is the most likely effect on the yields of lower-quality corporate bonds and on credit spreads of lower-quality versus higher-quality corporate bonds?
A
Both will increase.
explanation
During economic contractions, the probability of default increases for lower-quality issues and their yields increase. When investors anticipate an economic downturn, they tend to sell low-quality issues and buy high-quality issues, causing credit spreads to widen
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