Question

1. It is early 2015, and you are thinking about buying some Greek bonds.
   a. You know that Greek bonds have very risky. Why would you still want to buy them, given that there is a high chance of default and non-payment?
   b. For the following situations, sketch a demand and supply diagram and explain what happens with the 1) price, 2) quantity of bonds sold and 3) the interest rate. Write 1-2 sentences to explain.
   1. There are protests in Greece by the people who work for the government. They

   demand higher salaries, and so the government has to spend more and increase the

   budget deficit.

   2. Greek bonds are now traded on a stock exchange in the US, so you don't have to

      register on a European stock exchange to trade them.

   3. Bad news: apparently, the Greek government lied about some key economic

      indicators, making things look better than they are.

   4. Suddenly there is expectation that the Euro (that Greece uses) will have high

      inflation.

Answer 1

Hi,

Hope you are doing well!

Question:

Answer:

Bond: Bond is a fixed income instrument issues by a company or the government in which issuer promise to pay a fixed interest rate.

Risk associated with bond investment:

There are several risk are associated with the bond investment. These are: Credit risk, inflation risk, reinvestment and liquidity risk.

Credit Risk: Credit risk is associated with the repay of principle and interest amount. If a issuer falls into the financial crisis and get defaulted or bankrupt then issuer do not financial capable to pay the principle amount and interest amount.

Inflation Risk: Inflation risk is associated with the purchasing power of a bond’s future coupons and principal.When inflation increase then its Decreased the purchasing power of money and vice versa. In case of increasing inflation the real return will reduced.

Reinvestment Risk: Reinvestment risk is related with the interest rate in the economy or market. If interest rate falls then the bond holder will reinvestment the coupon and principle at lower interest rate.

Liquidity Risk: Liquidity risk is related with the buying and selling of bond in the market. If buyer is not available in the market then it will creat difficulty for the investor or bond holder.

Greece economic outlook:

Greece was fallen into a great recession during the 2008-09 global crisis and defaulted. Still Greece financial health is not good so, has a higher credit risk. So, investment in Greece bond is concern of higher credit risk. But normally a lower gade or rating bond offer higher interest rate or bond holders demand for a higher interest rate as a risk reward. So, a investor who has high risk taking capacity or high risk appetite can invest in the Greek bond for the higher return.

Situation 1:

There are protests in Greece by the people who work for the government.They demand higher salaries,and so the government has to spend more and increase the budget deficit.

Because Greece already in a big financial trouble and has a wide budget deficit and interest rate a the lowest level so, if the government full fill this demand of higher salary then it will increase the financial burden on the government and will increase the budget deficit more wider. Now government will sell the government bond in the open market and borrow money to fulfill the gap between revenue and spending. It will increased the GDP-Debt ratio. High GDP-Debt ratio will creat new challenge for Greek economy. It will also increase credit or default risk for bond holders.

Situation 2:

Greek bonds are now traded on a stock exchange in the US, so you don't have to register on a European stock exchange to trade them.

It will reduce the liquidity risk for US investors who have invested in Greek bond. It will help to the bond holder in buying and selling of Geek bond.

Situation 3:

Bad news: apparently, the Greek government lied about some key economic indicators, making things look better than they are.

It will increase the credit risk and liquidity risk also. It will creat a bad environment/opinion for the Greek bond in the market and seller of bond will increased rapidly after this news. A selling pressure will reduce the value of the Greek bond and investor will suffer badly and lose their money.

Situation 4:

Suddenly there is expectation that the Euro (that Greece uses) will have high inflation.

It will not directly affect the US investor. But inflation may lead to higher interest rates which is negative for bond prices. Bond price will reduce if interest rate increase in the European market that will negative for US investor. But Other side interest rate is concern of the nation's central bank and Greek economy is already in a deep recession and have no space for interest rate rising.

Thank You