Question

Your financial investments consistent of U.S. government bonds which mature in 20 years and share of stock in a technology company. How would you expect each of the following news items to affect the value of your assets? Explain. (Chapter 11)

a) Interest rates on newly issued government bonds fall

b) Inflation is forecasted to be much higher than expected (Assume that your bonds pay a set amount. Their payments are not affected by the inflation rate)

c) Below average stock market volatility reduce investors’ concerns about market risk

Answer 1

Ans

a) A decrease in interest rate on bonds leads to a decrease in demand for bonds leading to a situation of excess supply in the market causing the price of the bond to decrease.

b) The higher than expected inflation causes the aggregate supply to decrease because of increase in cost of production. This leads to rise in actual price level which at given nominal supply of money leads to fall in real money supply causing interest rate to rise and hence, bond price (or value) to fall.

c) Positive investor sentiments lead to increase in demand for bonds in the securities market causing and increase in the price of the bonds.

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