Exam 8011 Topic 1 Question 140 Discussion
Actual exam question for PRMIA's 8011 exam
Question #: 140
Topic #: 1
Question #: 140
Topic #: 1
For a corporate bond, which of the following statements is true:
I. The credit spread is equal to the default rate times the recovery rate II. The spread widens when the ratings of the corporate experience an upgrade III. Both recovery rates and probabilities of default are related to the business cycle and move in opposite directions to each other IV. Corporate bond spreads are affected by both the risk of default and the liquidity of the particular issue
I. The credit spread is equal to the default rate times the recovery rate II. The spread widens when the ratings of the corporate experience an upgrade III. Both recovery rates and probabilities of default are related to the business cycle and move in opposite directions to each other IV. Corporate bond spreads are affected by both the risk of default and the liquidity of the particular issue
Suggested Answer: B Vote an answer
The credit spread is equal to the default rate times the loss given default, or stated another way, default rate times (1 - recovery rate). It is not equal to the default rate times the recovery rate. Therefore statement I is not correct.
When ratings are upgraded by rating agencies, the spread contracts and not widen. Therefore statement II is not correct.
Both recovery rates and probabilities of default are related to the business cycle, and they move in opposite directions. Economic recessions witness an increase in the default rate and a decrease in the recovery rate, and economic expansions result in a decrease in the default rate and an increase in the recovery rates when default does happen. Therefore statement III is correct.
Bond spreads incorporate both the risk of default, but also considerations of liquidity in the case of corporate bonds. Hence statement IV is correct.
When ratings are upgraded by rating agencies, the spread contracts and not widen. Therefore statement II is not correct.
Both recovery rates and probabilities of default are related to the business cycle, and they move in opposite directions. Economic recessions witness an increase in the default rate and a decrease in the recovery rate, and economic expansions result in a decrease in the default rate and an increase in the recovery rates when default does happen. Therefore statement III is correct.
Bond spreads incorporate both the risk of default, but also considerations of liquidity in the case of corporate bonds. Hence statement IV is correct.
by Clementine at Aug 30, 2026, 01:15 PM
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