Question

Australian corporate bonds can now be issued with the same prospectus as for previous issues, simplifying the process.

As a result, the corporate bonds' yield __________ while the stock of bonds in the financial system ___________.

	A.	decreases; increases
	B.	decreases; decreases
	C.	increases; increases
	D.	increases; decreases

Answer 1

Price and yield of a bond are inversely related. If the price of bonds decreases, then the yield required for the bond increases.

In this case, since the process for issuing corporate bonds has been simplified by allowing the usage of the same prospectus as before, the supply of corporate bonds in the market is expected to increase. More number of corporates would be inclined to raise debt by issuing bonds compared to the earlier time when there was a natural pushback from the complex and costlier process involved in raising debt through bond issue using new prospectus on every new occasion.

Due to additional supply of corporate bonds, the price of corporate bonds is expected to decrease after reaching equilibrium from the opposite forces of supply and demand as can be seen in the following supply demand graph:

Supply curve S1 is expected to have a parallel shift to S2 due to simplifying process of issuing debt. Demand curve is not expected to change. Thus the equilibrium price point is expected to move from a higher level of P1 to a lower level of P2, leading to increase in expected yield due to inverse price-yield relationship and in the process increase the stock of bonds in the market.

As a result, the corporate bonds' yield increases while the stock of bonds in the financial system increases.