The spread between the interest rates on Baa corporate bonds and U.S.

The spread between the interest rates on Baa corporate bonds and U.S. government bonds is very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

What will be an ideal response?

ANSWER

During the Great Depression many businesses failed. The default risk for the corporate bond increased compared to the default-free Treasury bond. The demand for corporate bonds decreased while the demand for Treasury bonds increased resulting in a larger risk premium.