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In: Finance

Tje Fed dropped its policy rate from 1.5% to zero in March,2020 in response to the...

Tje Fed dropped its policy rate from 1.5% to zero in March,2020 in response to the economic lockdown due to the pandemic. You have two bonds in your portfolio: A and B. Bond A has been downgraded from AAA to BBB whereas Bond B has been upgraded from B to BB by Moody's. What is the net effect on bind prices of the police rate drop and credit chargers?
A. Bond B prices would definitwly increase
B. Both prices would defenitely increase
C. Bond B price would definetily decrease but bond A price would definetly increase.
D. Both A and B prices would decrease
E. Bond A prices would definitely increase

Solutions

Expert Solution

A) Bond B prices would definitely increase

Explanation: There is an inverse relationship between price and policy rate , and there is a direct relationship between credit rating and price.

As the policy rate decreases the price of both the bonds will increase, as there is an inverse relationship between them.

In case of bond A, the ratings are degrading, which will lead to decrease in the price of the bond. The net effect of policy rate and credit changes cannot be determined, as both are in different directions.

Where as in case of Bond B, the ratings are increasing, which will lead to increase in the price of the bond. The net effect of policy rate and credit changes will lead to increase in the price of Bond B.

jeff jeffy answered 2 years ago
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