Question

Q2 Briefly describe the difference in the bond market in general and the stock market in the context of investment and return. Why is corporate bond investment usually riskier than investing in US Treasury securities?

Q3. Estimate the rate of return (yield to maturity) if you as an investor purchase a one-year US TN at the market price of $955 with an FV of $1,000. Make sure you show the numerical estimation by using the yield equation.

Q4. Draw a hypothetical demand and supply curve for S&P 500 stocks and briefly explain the effects of unexpected increase in inflation rate caused by a sudden rise in energy prices.

Q5. Draw a demand and supply curve of the loanable funds market and explain the effects on equilibrium prices and quantities of loanable funds in response to the situation described in Q4.

Q6. Suppose the increase in tariffs on imports of goods and services from China and EU countries caused a capital flight of currency from the United States. Show the effects this would have on US exports, imports, and trade balances.

Answer 1

Q2. There are a variety of options available for investment in the market, which also includes stocks, bonds, t-bills etc. Bond is paper signifying that the bond owner has given the debt to the bond seller. They generally carry a fixed rate of interest.  On the other hand, holding stocks means that an individual has a stake of ownership in the firm. Hence he/she is a stakeholder in the firm and his/her future earnings on the stock is based on the performance of the firm on the stock market. Hence one can infer that stocks carry inherent risk with them, however, bonds are lesser riskier. Also in the case of the firm going bankrupt or liquid, bond owners are given priority in repayment rather then the stock owners which again increases the risk in stock investment. However, as we know risk and reward generally go hand in hand, so higher the risk in stocks, higher is the possibility of profits are.

Corporate bond investment is usually riskier than investing in US Treasury securities. The riskiness of investment in any instrument is perceived based on the ability of the firm/organization to pay back the investment in adverse economic scenarios. Considering the more financial stability of US Treasury over corporates, it is more expected to get payback from US government based instruments rather then from corporates which have lesser sources of revenue with them