10. (Mishkin 12.7) What is a credit spread? Why do credit spreads rise significa

Question

10. (Mishkin 12.7) What is a credit spread? Why do credit spreads rise significantly during a financial crisis? 11. (Mishkin 12.15) Why is the originate-to-distribute business model subject to the principa agent problem? 12. (Mishkin 20.2) "A country is always worse off when its currency is weak (falls in value)." Is this statement true, false, or uncertain? Explain your answer. 13. (Mishkin 20.6) When the Federal Reserve conducts an expansionary monetary policy, what happens to the money supply? How does this affect the supply of dollar assets? 14. (Mishkin 20.11) If the Indian government unexpectedly announces that it will be imposing higher tariffs on foreign goods one year from now, what will happen to the value of the Indian rupee today? 15. (Mishkin 20.22) If the price level recently increased by 20% in England while falling by 5% in the United States, by how much must the exchange rate change if PPP holds? Assume that the current exchange rate is 0.55 pound per dollar.

Explanation / Answer

10. In simple words, a credit spread refers to the difference in yield between two bonds having similar maturity but different quality because of underlying risks. For example, if the yield of a 10-Year Treasury bond is 7% and that of a 10-year corporate bond is 4%, the credit spread is 300 basis points.

At the time of recession, the credit spread widens because the corporates are more likely to default in a recession than the US treasury. So, investors demand a higher interest rate on the corporate bonds. This is why the difference in yield of treasury bonds and corporate bonds increase i.e. the credit spread increases.

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