Question

Everything else held constant, if the federal government were to guarantee today that it will pay creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds will ________ and the interest rate on Treasury securities will ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Answer 1

Answer:

The answer is: C) decrease; increase

Explanation:

When the US government guarantees a corporation´s bonds, you know the government will pay you back whatever happens. The US government has one of the best reputations in the world. So that will immediately decrease the interest rate of the corporation´s bond since it basically becomes a risk free investment.

The US government will absorb the risk from the corporation´s bonds, so depending on the total value of the bonds, the interest rate on Treasury securities might increase a little. For example, if the total amount of the bond emission was $20 billion for a corporation like Citigroup, the interest rate might increase a few points. If the amount wasn´t very large, probably the effect will go unnoticed, but there´s no chance the interest rate will decrease.