Explanation

Credit spread is the additional yield that investors demand for bearing credit risk compared to risk-free securities. It is primarily determined by:

• Credit rating: Higher credit ratings (better quality) lead to lower credit spreads
• Default probability: Higher default probabilities lead to higher credit spreads
• Recovery rate: Lower recovery rates lead to higher credit spreads

Analysis of each option:

• A. Credit rating: An increase in credit rating (improvement) leads to a decrease in credit spread. Better credit quality means lower risk, so investors demand less compensation.

• B. Annual default probability: An increase in annual default probability leads to an increase in credit spread, not a decrease. Higher default risk requires higher compensation.

• C. Cumulative default probability: An increase in cumulative default probability leads to an increase in credit spread, not a decrease. Higher overall default risk over the security's life requires higher compensation.

Therefore, only an increase in credit rating will lead to a decrease in the credit spread.