Chapter 3 Homework: Bonds and Loanable Funds Identify which side of the bond mar

Question

Chapter 3 Homework: Bonds and Loanable Funds Identify which side of the bond market is affected by each of the following changes Change Investment tax treatment Relative returns on bonds Business expectations Wealth levels in society Relative riskiness of bonds Information costs incurred by investors Liquidity of bonds Government budget deficits Expected inflation Supply Demand Suppose that relative return on bond decreases Adjust the following graph to illustrate the effect of the change on the bond market Demand Supply

Explanation / Answer

Demand will increase or decrease depending on the decrease or increase respectively in the capital gains tax.

2. Relative retuns on bonds - Demand side

Demand is high if the returns are high

3. Business Expectations - Supply side

If the Government tax revenues are high; supply decreases; bond yield increases;

4. Wealth levels in society - Supply increases to reduce the liquidity

5. Relative riskiness of bonds - Demand side

Demand decreases with increase in risk; yield decreases

6. Information costs incurred by investors - Demand side; demand decreases if costs are high for determining the fate in the near future

7. Liquidity of bonds -

Demand side: Demand increases if liquidity is high; the number of trades increases

8. Government budget deficits - Supply increases for financing the deficit

9, Expected inflation - Supply side - Bond supply is increased to increase the inflation levels; QE is an example

If relative return decreases, bond prices increase, demand decreases; bond prices & returns

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