Consider a One-Year Zero-Coupon Defaultable Bond $r$ And $S$ Denote, Respectively, the Risk-Free Interest Rate and the Spread on Denote

question 16

Multiple Choice

Consider a one-year zero-coupon defaultable bond. Let $r$ and $S$ denote, respectively, the risk-free interest rate and the spread on the bond, where both are expressed in simple terms with annual compounding. Suppose the risk-neutral probability of default $\lambda$ and the recovery rate of the bond in default $\phi$ remain fixed. Then, an increase in the risk-free rate must be accompanied by

• A) An increase in the spread.
• B) A decrease in the spread.
• C) No change in the spread.
• D) A change in the spread that can be positive, negative, or zero.

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