If rates are expected to increase in the future, should investors invest in long-term bonds...

If rates are expected to increase in the future, should investors invest in long-term bonds or short-term bonds (or other short-term securities now) now (i.e., today)? Explain.

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Expert Solution

There is an inverse relationship between bond price and interest rates. When interest rates goes up , bond price decreases. Long term bonds have a greater impact when the interest rate changes. This is because long term bonds have a greater duration .That is the probability that there will be an increase in the interest rate is more with the longer period than for shorter period.

Investors have a relatively fixed conception of the normal or critical interest rate and compare the current rate of interest with such normal or critical rate of interest.

If investors consider that the current rate of interest is low compared to the normal or critical interest, they expect a rise in the interest rate. So they will invest less in bonds.

So when the interest rates are high ,bond prices will fall .So it seems to be less attractive for the investors and they will be willing to pay only less.This is because on selling this bonds , they will get only low earnings.So investing on short term bonds is favourable for investors as they are less fluctuated to interest rate. So investing on short term bonds is a good option.

ekkarill92 answered 1 year ago

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