Question

5. Suppose you have data on the prices of bonds in the Canadian market for every day in the year. How could you determine the timing of the Bank of Canada’s interest rate policy statements using the assumption that the market has no advanced knowledge of these rate decisions and there are no business cycles? Is it possible to do the same thing without these two assumptions?

Answer 1

I have the data on bond prices for a year. I will determine the timing of the central banks interest rate changes by determining the change in bond prices as the bond prices would change whenever there is a change in interest rates. Cause whenever the central bank increases the interest rates, the bond prices would fall as there is an inverse relationship.

Now without the two assumptions, I would not be able to determine the exact timing of the change, but I would be able to gauge whether the central bank has increased or decreased the interest rates as there would be a much more pronounced drop which will stay for a longer duration and not fluctuate constantly if interest rates are increased by the central bank and vice versa. It all depends on whether the business cycle is stable then the change would stay for a longer duration, but if the business cycle is highly volatile, then the chart would also fluctuate, as stock prices also affect the bond prices.