Question

Prompt You are an economic advisor to General Motors Company (GM), a multinational corporation based in Detroit, Michigan that designs, manufactures, markets, and distributes automobiles and offers myriad financial services. GM employs more than 180,000 people and serves six continents. Currently, GM owns very large quantities of long-term U.S. Treasury bonds and long-term AAA-rated corporate bonds. You confer daily with the firm's chief financial officer, Ms. Dhivya Suryadevara. Today, Ms. Suryadevara asks you to assess how each of the following announcements will affect current prices and yields to maturity of various types of bonds. In your response to each announcement Ms. yadevara presents you, please carefully defend your reasoning: specifically, explain how the announcement affects current movements of and along the demand and supply curves for the types of bond(s) in question. For simplicity, assume the supply curve of each type of bond is vertical and, thus, the quantity supplied of each type of bond is insensitive to movements in its price. Part 1: Later this morning, Ms. Suryadevara will appear on CNN, where she will announce that, in March 2020, she will double the firm's holdings of long-term AAA-rated corporate bonds. A purchase this large would move financial markets. Ms. Suryadevara asks you to assess how her announcement this morning will affect today's prices and yields to maturity of long-term U.S. Treasury bonds and long-term AAA-rated corporate bonds. Part 2: Later this morning, Ms. Suryadevara will appear on CNN, where she will announce that, in her expert opinion, long-term AAA-rated corporate bonds are far less liquid than most holders of these bonds realize. Ms. Suryadevara's expert opinion would move financial markets. Ms. Suryadevara asks you to assess how her announcement this morning will affect today's prices and yields to maturity of long-term U.S. Treasury bonds. Part 3: Today, Ms. Suryadevara apprises you of a discussion she had recently with House Budget Committee Chair John Yarmuth (D-KY). In the discussion, Chair Yarmuth shared his concern that, later this year, Congress might fail to raise the U.S. debt ceiling and, thus, the U.S. Treasury might at least technically-default on its debt. Later this morning, Chair Yarmuth will appear on CNBC, where he will publicly air his concern. Ms. Suryadevara asks you to assess how Chair Yarmuth's announcement this morning will affect today's prices and yields to maturity of long-term U.S. Treasury bonds.

In each part, a different situation of her speech is mentioned.

In part 1: Assess the morning announcement based on how it will affect today’s prices and yields to maturity of long-term U.S. Treasury bonds and long term AAA rates corporate bonds.

In part 2 and 3: Assess the morning announcement based on how it will affect today’s prices and yields to maturity of long term U.S. Treasury bonds.

Answer 1

Part 1 Bond price and yield to maturity fluctuations are based on demand of the bonds, assuming supply and macroeconomics factors constant. Since the demand for the corporate bonds increased, the yield to maturity will decline and the price will increase. The announcement will not affect the price or yield to maturity of long term US Treasury bonds since corporate bond market does not affect treasury yield or price. This is based on assumption that the company will not liquidate its holdings in long tem US treasury bonds to buy corporate bonds Part 2 A corporate bond's liquidity impacts the investors' ability to make large-scale, low-cost trades without triggering a noticeable price change. Post announcement, there might be an exodus from the corporate bonds to long term US treasury bonds, which will increase the demand for the treasury bonds Higher demand will lead lower yield to maturity and higher prices. Part 3 Possibility of default will raise investors' concerns regarding the issuer's ability to pay, and the investors will demand a higher yield to hold the bonds. Yield to maturity of long term US treasury bonds will increase and the price will decrease.