Question

Relate price changes in bond markets to price changes in stock markets. Explain why prices move or do not move together.

Answer 1

Bonds are issued when business corporations borrow from the public. The borrowing through issue of bonds may be for a short period or long period. The price of bonds depends upon the movement of rate of interest. A higher rate of interest leads to lower price for bonds whereas as a lower interest rate increase the price of bonds.

The stocks are fund raising through the issue of ownership of companies. When a person buys a stock he acquires the ownership interest of the company. No interest payment is attached to the stocks. The stock holders have no claim of interest but they have the privilege to get profit share of the company which has been declared at the annual general meeting of the company. The stock price depends upon the economic strength of the country and the profit of the issuing company. During times of economic prosperity and increased profit of the companies and profit share of the holders increase prices of stocks.

A business uncertainty creates more demand for bonds than stock. Thus in case of a sluggish economy or business uncertainty the demand for bond increases and that of stocks decrease. The investors try to invest in bonds rather than stocks. Thus the bond price increase and stock price decrease. Therefore the relation between bond price and stock price is inverse.

In case of a strong economy or the economy is experiencing business certainty, the demand for bonds decrease and that of stocks increase. The investors opt to invest in stocks rather than bonds. This will increase the price of stocks and decrease the price of bonds. In short the bond price and stock price does not move in the same direction but actually move in the opposite direction.

Another reason of inverse relation between bond price and stock price is the inflation created by business prosperity. During times of business prosperity the stock prices rises and the increased profit of the investors and business heat up inflation. The central during this time increase the rate of interest by following dear money policy. This increased rate of interest lower the bond price. On the opposite during times of recession the stock price decrease due to bad performance of the economy and the decline in profit of the share holder and the company reduce the inflation. In such a scenario the central bank lower the rate of interest rate by a cheap money policy. Thus the rate of interest falls and bond price increase. In short the stock and bond price does not move in the same direction but they move in opposite direction.