Suppose currently 10-year Treasury note offers 2.8% yield and the average yield on investment grade 10-year corporate bonds is 4.4%. Calculate the risk spread. Predict what will happen to the yields of corporate and treasury bonds as well as the risk spread if the federal government guarantees today that it will pay to bondholders if the corporations go bankrupt in the future.

Answer and Explanation:

The computation of the risk spread is shown below:

As we know that

Risk spread = Average return on investment grade for 10-year corporate bonds - offered currently 10-year Treasury note

= 4.4% - 2.8%

= 1.6%

In the case of prediction for corporate yields and treasury bond for guaranteed the amount today than it would lead to generating the money at a lesser cost due to which it results into reduction of corporate bond for the treasury note level

So the risk spread is between the treasury notes and corporate would invisible