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Using the liquidity preference approach/modelexplain what happens to the interest rate when the riskiness of bonds...

  1. Using the liquidity preference approach/modelexplain what happens to the interest rate when the riskiness of bonds rises.  A graph is required for this part of the question.  Make sure that youlabel the graph—axes, curves, and significant points—appropriately.  Make sure also that you include a few sentences by way of explanation.
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Answer #1

In the market for bonds, demand curve shifts to the left when there is an increase in risk involved and a decrease in liquidity of bonds. This implies that in the bond market, there is a reduction in the price level and the quantity of bonds demanded and supplied. People will now switch to money market where demand for money increases. This shifts the money demand curve up and raises the level of interest rate.

Hence, when riskiness of bonds rises, bond prices fall and rate of interest rises.

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