During the European debt crisis in 2012, an article in the Wall Street Journal noted: “The...

During the European debt crisis in 2012, an article in the Wall Street Journal noted: “The cost of credit default swaps on Italian and Spanish government and corporate debt surged last week. ” What does an increase in the price of CDS on Italian and Spanish government and corporate bonds indicate about the bonds? What likely happened to the yields on those bonds?

Expert Solution

Price of bond CDS will be higher (lower) if bonds are more (less) risky, due to higher (lower) default risk.

Also, lower (higher) investor confidence on the underlying assets (bonds) can increase (decrease) the price of CDS.

In either case, demand for such bonds will decrease, shifting the demand curve to left, lowering both bond price and quantity of bonds.

Bond price and yield being negatively related, a decrease in bond price will increase bond yield.

Rahul Sunny answered 2 years ago

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