Question

1.In 2009, global investors began to regain confidence in the financial system and reversed the flight to safety that had taken place during the depths of the financial crisis. Make use of a graph of the market for corporate bonds to show the impact on corporate bonds prices and yields.

Answer 1

Following figure shows the Market for Corporate Bonds -

Initially, the market for corporate bonds was in equilibrium at point E, where demand curve for corporate bonds, D, was intersecting the supply curve of corporate bonds, S.

The equilibrium price was P per bond and equilibrium quantity traded was Q bonds.

Now, it has been provided that global investors has regained their confidence in US economy and has started moving capital back to US. This regaining of confidence and capital inflow in US will result in an increase in demand for corporate bonds as investors will now feel safe to invest in these bonds on back of economic recovery.

This increase in demand for corporate bonds will shift the demand curve for bonds to the right from D to D1.

New equilibrium is attained at point E1, where new demand curve, D1, is intersecting the supply curve of bonds, S.

New equilibrium price is P1 and new equilibrium quantity traded is Q1 bonds.

It can be seen that given development has resulted in an increase in price of bonds.

Price of bonds and yield from bonds move in opposite direction.

So, this increase in price of bonds will lead to fall in yields.