Credit spread is mostly likely to narrow during …a) economic expansionb) economic recessionc) period of flight-to-quality

The correct answer is:

a) Economic expansion

Here's why:

1. Credit spread refers to the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality. It is essentially the risk premium for investing in a bond that has credit risk compared to a risk-free bond.

2. During an economic expansion, businesses generally perform well, unemployment is low, and consumers spend more. This reduces the perceived risk of corporate or other non-government bonds defaulting.

3. As the perceived risk of default decreases, the yield on these bonds decreases. At the same time, the yield on risk-free Treasury bonds remains relatively stable. This causes the credit spread to narrow.

4. In contrast, during an economic recession or a period of flight-to-quality (when investors move their capital away from riskier investments and towards safer ones), the perceived risk of default increases. This causes the yield on riskier bonds to increase and the credit spread to widen.