Upon a downgrade from AA to BBB, the bond's yield tends to

Upon a downgrade from AA to BBB, the bond's yield tends to

• A. Decrease
• B. Increase
• C. Remain the same
• D. Fluctuate unpredictably

Answer: (B)

When a bond’s credit quality worsens, its yield tends to rise. Downgrading from AA to BBB signals higher credit risk and a greater chance of default, so investors demand a higher return to compensate for the added risk. As a result, the bond’s yield increases (and its price would typically fall to reflect the higher yield). The spread over risk-free benchmarks would also widen. The other options don’t fit because they either ignore the increased risk, imply no change, or ignore the typical market response to a downgrade.

When a bond’s credit quality worsens, its yield tends to rise. Downgrading from AA to BBB signals higher credit risk and a greater chance of default, so investors demand a higher return to compensate for the added risk. As a result, the bond’s yield increases (and its price would typically fall to reflect the higher yield). The spread over risk-free benchmarks would also widen. The other options don’t fit because they either ignore the increased risk, imply no change, or ignore the typical market response to a downgrade.