Question

During the European debt crisis in 2012, an article in th 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?

Answer 1

Price of CDS on bonds will increase if bonds become riskier due to higher default risk. Another possibility that gives rise to higher CDS cost is a lack of investor confidence on the underlying assets (bonds) here.

It means that the demand for such bonds will fall, shift the demand curve for such bonds leftward, decreasing both bond price and quantity of bonds traded.

Since bond price and yield are inversely related, lower bond price will increase their yield.