What does spread tightening in the context of corporate bonds indicate? The yield of the corporate bond is getting closer to the yield of risk free gov bonds The yield of long term corporate bonds are getting closer to the yield of short term bonds The company has a higher risk of default on its debt
The Correct Answer and Explanation is:
Spread tightening in the context of corporate bonds refers to the phenomenon where the yield difference between corporate bonds and risk-free government bonds becomes smaller. This generally happens when the yield of a corporate bond is getting closer to that of risk-free government bonds, which indicates a decrease in the perceived risk associated with the corporate bonds.
Corporate bonds are typically issued with a higher yield than government bonds due to the additional risk investors take on, which includes the possibility of default by the issuing company. The spread between the two yields reflects the level of this risk. When spread tightening occurs, it suggests that investors view the issuing company as less risky, possibly because of improved financial performance or a stronger economic environment.
This tightening spread can happen for various reasons. For instance, if the company’s financial health improves, its credit rating may be upgraded, leading investors to demand less of a yield premium over government bonds. It can also occur during periods of overall market optimism, when risk appetite increases, and investors are more willing to take on corporate bonds, thus reducing the spread between corporate and government bond yields.
It is important to note that spread tightening does not necessarily mean that the company has less risk of default. Rather, it indicates that the market perceives the company as being less risky compared to before, or that there is less perceived risk in the corporate bond market overall.
In summary, spread tightening typically indicates that the yield of the corporate bond is getting closer to the yield of risk-free government bonds, reflecting a reduction in perceived risk associated with the corporate bond.
