Question

In a closed economy, how would each of the following events affect bond price and market interest rate? Use the figures of both bond market and market of loanable funds to illustrate the changes to the interest rates.

Many investors feared that Greece may default on its bonds. Show how this affected the prices and interest rates on Greek bonds.

In 2008, the liquidity of mortgage-backed securities declined significantly. Show how this affected the price and interest rate of mortgage-backed securities.  

The expected gains on stocks decrease, while the expected returns on bonds do not change. Show how this affected the price and interest rate of bonds.

Answer 1

Fear of default reduced the demand of Greek bonds, leading to a lower price and higher interest rate.

The liquidity of the stock market has been increase by interests trading of stocks. The increase in the desirability of stocks all being equal, result in a shift to the left in the demand curve for bonds,lowering the price and raising the interest rate.

There is an inverse relationship between bond prices and interest rates meaning that as interest rates rise,bond prices fall, and as interest rate fall and bond price rise. The longer the maturity of the bond, the more it will fluctuate in relation to the interest rates.

So, since the expected gains on stock decreased bond price decreases, So increase rate of bonds increase.

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