September 2018 1 (iv)

Apologies but I am struggling to understand these points. By 'greater exposure to corporate bonds' are you referring to this particular company having a very high SCR component relating to credit spreads widening? This does suggest that the company is more exposed to the risk of credit spreads widening than it is to the risk of interest rates increasing - but the question isn't asking about that.

Your phrase 'the interest rate of corporate bonds' is a little unclear: presumably you mean the yield on corporate bonds rather than the coupon rate? If interest rates increase, so will the yields on corporate bonds: this is a strong positive correlation. Are you thinking instead about the relationship between credit spreads widening and interest rates increasing? (This inherently feels like it would be a positive correlation too though: more likely to have defaults when interest rates are higher?)

 

If interest rates increased by 1% then the yield on corporate bonds would also be expected to increase by 1% (ignoring any impact on the spread) - assuming an increase throughout the relevant yield curve. If anything, an increase in interest rates would be more likely to result in credit spreads widening (higher chance of default due to the pressure from the greater cost of borrowing and a potential negative impact on customer demand) rather than credit spreads narrowing - hence my comment about more likely to be positively correlated.

 

Yes that's a fair observation, but this is likely to be relatively second order.