Explanation
Credit-risky bonds (also known as high-yield bonds or junk bonds) are bonds with lower credit ratings that carry higher default risk. Their performance is influenced by several factors:
Why Option A is correct:
- Periods of high demand for credit-risky bonds lead to price appreciation
- Increased demand typically occurs when investors are seeking higher yields in a low-interest-rate environment
- Higher demand reduces yield spreads and increases bond prices
Why Option B is incorrect:
- Widening credit spreads indicate that investors are demanding higher compensation for credit risk
- This typically occurs during economic uncertainty or deteriorating credit conditions
- Widening spreads cause bond prices to fall, negatively impacting performance
Why Option C is incorrect:
- Weakening economic conditions increase default risk for credit-risky issuers
- During economic downturns, companies with weaker credit profiles face greater financial stress
- This leads to wider credit spreads and lower bond prices
Key Concept: Credit-risky bonds benefit from favorable credit conditions, strong investor demand, and narrowing credit spreads. Their prices move inversely to credit spreads - when spreads narrow (indicating improving credit conditions), bond prices rise, and vice versa.
