Question

Explain graphically, how increased government bond issuance can result in a decrease of corporate bond issuance, and lower corporate bond prices.

Answer 1

Answer : Yes government bonds issuance can result in a decrease of corporate bond issuance and its prices.

Let us discuss it in detail. For understanding that first let us see why investors purchase bonds --

1] For steady income : Many investors feel investment in bonds as secured and again it is with fixed rate of interest unlike shares . Particularly investors who are retired from services feel bonds extreem important.

2] For reduction of portfolio risks : For investors not only rate of return is important bue safety and security of their money is aslo most important. Bonds that to particularly government bonds are called safest or guilt edged securities which are secured against the market risks.So with high return of investments like shares which are also risky , the investors prefer to balance the portfolio by purchasing government bonds which yield good rate of return eventhough less than shares but is guaranteed and safe.

3] Helpful in economic downfall : The phases of trade cycles are always going on and are not much perfectly predictable. So particularly in recession or temporary downfall of markets investors loses money invested in shares. But even in that critical situation the investment particularly in government bonds is safe and yielding steady returns.

The above discussion clearly shows that due to investors confidence about government bonds because of steady rate and safety of investments than corporate bonds , they always prefer government bonds than corporate bonds. The corporate bonds even they may offer attractive rate are prone to market risks. In recent market trends investors observed downfall of reputed corporates .

The comparatove yield of government bonds is always better than corporate bonds due to steadyness, riskfreeness and tax incentives.   

The yield curve – also called the term structure of interest rates – shows the yield on bonds over different terms to maturity. The ‘yield curve’ is often used as a shorthand expression for the yield curve for government bonds.

To graph the yield curve, the yield is calculated for all government bonds at each term to maturity remaining. For example, the yield on all government bonds with one year remaining until maturity is calculated. This value is then plotted on the y-axis against the one year term on the x-axis. Similarly, the yield on government bonds with three years remaining until maturity is calculated and plotted on the y-axis, against three years on the x-axis, and so on. The policy interest rate forms the beginning of the government yield curve, because it is the interest rate with the shortest term in the economy (overnight).

The yield curve for government bonds is also called the ‘risk free yield curve’. The expression ‘risk free’ is used because governments are not expected to fail to pay back the borrowing they have done by issuing bonds in their own currency.

The Yield Curve

Other issuers of bonds, such as corporations, generally issue bonds at a higher yield than the government, as they are more risky for an investor. This is because the loan or interest payments in the bond may not be paid by the corporation to its owner at the agreed time. When this occurs, it is called a ‘default’.