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5. As the price of bonds fall, what is the effect on the following: ​The issuer...

5. As the price of bonds fall, what is the effect on the following:
​The issuer of the bond
​The purchaser of the bond
​The interest rate
​The effect on the economy
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Answer #1

Price of bonds fall when the demand for the bonds decline. Decline in bond prices is accompanied by increase in the bond yield, in other words, decline in bond prices result in increase in the interest rate. This is needed to provide incentive for the people to invest in bonds.

So, when bond prices fall the issuer of the bond faces higher servicing cost, as interest rate rises. On the other hand, purchaser of bonds gain as they not only buy bonds at lower prices but they will also receive higher returns.

The increase in the interest rate that is accompanied by decline in the bond prices, has a negative impact on the economy. This is because higher interest rate means that firms will find it expensive to borrow for investment in plant and machinery. The decline in investment demand will adversely affect the level of aggregate demand in the economy.

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