Question

For each of the following indicated the expected impact on the U.S. Treasury bond market. Be certain to indicate what curve(s) is (are) shifting. a. An increase in domestic wealth b. An increase in default risk of Greek government bonds c. Rising inflationary expectations d. Strong forecasts for coming stock market price appreciation ( a booming stock market is forecast)

Answer 1

(A) This would increase the demand for bonds in the bond market. The demand for bonds curve would shift to the right because people have more wealth and would invest in interest earning instrument such as bonds.

(B) This would increase the demand for US treasury bonds. The demand for bonds will shift to the right. This is because, the default on Greek govt bonds has increased so people would shift their investment from Greek bonds market to US bonds market and invest more in US government bonds. Hence, the demand curve for US bonds market would shift to right.

(C) As the inflationary expectations rises, the demand for bonds decreases and demand curve for US government bonds shift to left because bonds are fixed interest securities and with rising inflation, real interest earned from bonds decreases.

(D) This would decrease the demand for US bonds as people would invest more in stock market in search for higher returns due to expecting boom in the stock market. The bonds pays a fixed return to investors while investing in stock market can give you returns more than the returns in bonds during boom. Hence, the demand for bonds decreases and the demand curve would shift to left.