Question

Refer to the figure on your right. Suppose that the health of the economy

deteriorates so that the probability of corporations defaulting on their bonds

increases.

1.) Use the line drawing tool to show the shifts in the supply and demand of corporate bonds. Properly label this line.

2.) Use the point drawing tool to to show the change in the price of corporate bonds. Label this point

'Upper P 2P2 '

Answer 1

Following figure shows the Market for Corporate Bonds -

As above figure shows, initially, the market for corporate bonds was in equilibrium at point E1, where demand curve for corporate bonds, D1, was intersecting the supply curve of bonds, S1.

The equilibrium price of corporate bonds was P1 and the equilibrium quantity of corporate bonds was Q1.

Now, it has been stated that the health of the economy deteriorates so that the probability of corporations defaulting on their bonds increases.

This increase in chances of default will induce the investors to decrease their exposure to corporate bonds which in result will lead to decrease in demand for corporate bonds.

This decrease in demand for corporate bonds will shift the demand curve for bonds to the left.

New equilibrium is attained at point E1, where new demand curve for corporate bonds, D2, is intersecting the supply curve of bonds, S1.

The new equilibrium price of bonds is P2 and the new equilibrium quantity of bonds was Q2.