Question

Know the following two equations i.e. fill in the blanks with the corresponding signs:

Bond D = f(     )?

Bond S = f(    )?

Put the signs over each explanatory variable.

Answer 1

The demand for bonds, that is, the investors’ decision to buy bonds depend on several factors such as follows:

1. Wealth (W): Wealth increases the demand for bonds. Thus, it is positively related with demand for bonds.
2. Expected return (R): If the return on bonds is higher, the demand will be higher. Thus, it is positively related with demand for bonds.
3. Expected Interest Rate (re): if interest rate increase, holding bonds become less attractive. Thus, it is negatively related with demand for bonds.
4. Inflation expectation (P): If inflation is expected to increase, then it becomes less attractive to hold bonds. Thus, it is negatively related with demand for bonds.
5. Relative risk (RR): If risk increases, then demand for bond decrease. Thus, it is negatively related with demand for bonds.
6. Relative liquidity (RL): If bonds become more liquid, demand for bonds increase. Thus, it is positively related with demand for bonds.

Thus, Bond D = f(W (+) , R (+) , re (-) , P (-) , RR (-) , RL (+))

The supply of bonds depend on:

1. Government budget (G): When the government budget is in deficit, they finance borrowing by selling bonds. Supply of bonds increase. Thus, it is negatively related with supply for bonds.
2. Inflation expectation (P): If inflation is expected to increase, borrowers will issue more bond and supply will increase. Thus, it is positively related with demand for bonds.
3. Business environment (B): If environment improves, bond supply will increase. Thus, it is positively related with demand for bonds.

Bond S = f(G (-) , P(+) , B(+))