Question

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

Answer 1

When Government start to issue more bonds than the existing volumes of bond available in the market, to attract more investors they have to sell the bond for higher yield. Since governments bonds are considered risk free and Corporate bonds yields are based on government yield + risk premium, the corporate bond yield also has to be increased. The increased yield is reflected through decrease in bond price since par value of the bond will be same as before.

This makes the financing through corporate bonds expensive for companies and hence they starts issuing less bonds and go for other financing methods. In another words, the more government debt increases more competition in economy and more supply of bonds with no change in demand. In order to factor in the less demand, they need to increase the bond yield which eventually increases the yield of corporate bonds. These effects makes the financing through corporate bonds less attractive for corporates.