Question

If stocks get riskier, explain what happens to the market for Treasury bonds? Be sure to explain what is happening with equilibrium price, interest rate and equilibrium quantity in the Treasury bond market

Answer 1

If stocks get riskier then investors would prefer to move their money to less risky assets.

Treasury bonds are considered low risk or no risk financial instruments.

So, with stocks becoming riskier, investors will invest more in Treasury bonds. This will result in an increase in demand for Treasury bonds.

The increase in demand for Treasury bonds will shift the demand curve for Treasury bonds to the right.

Following graph shows the market for Treasury bonds -

The above figure shows that an increase in demand for Treasury bonds has shifted the demand curve for Treasury bonds to the right from D to D1.

This has resulted in an increase in price and quantity in Treasury bond market.

So,

The equilibrium price of Treasury bonds will increase.

The equilibrium quantity of Treasury bonds will increase.

There exists an inverse relation ship between price of bonds and interest rate.

Thus,

This increase in the price of Treasury bonds will result in a decrease in interest rate.