Question

what would happen to the risk yield spread (coporate bond - government bond) when stock market increase? (increase or decrease)

and what is reh reason of it?

Answer 1

When risk yield spread goes up then stock market goes down and vice-versa

It could be for the following reasons:

Firstly, when bond yield spread rises, the yield on the bonds become more than the equity yield. But with bond yield spread higher , investors and asset allocators may find debt relatively more attractive compared to equity in risk adjusted terms.

Secondly, why higher yield spreads are negative for equities is beacuse, when rates go up, the cost of debt goes up and the cost of capital goes up. This cost of capital is used to discount future cash flows to arrive at the valuation of companies. That means higher cost of capital will depress valuation of equities. That will be evident in the markets.

When yield spread goes up, mid-sized companies will find it increasingly difficult to raise fresh debt at competitive yields. This increases the risk of bankruptcy .