Question

if downward revision of inflation is expected what do we know about the bond market? if...

if downward revision of inflation is expected what do we know about the bond market? if inflation decreases interest rates decrease if interest decreases price of bond increases bond demand increases mean price of bond increases so shift demand curve to the right what do we know about supply? also if supply moves more than demand quantity decreases if demand moves more than supply quantity increases. Please tell me if my assumptions are correct and what else I should know about the supply demand quantity price interest.

Homework Answers

Answer #1

PV of a bond, which is also the price of the bond in the secondary market is given as

PV = 50/(1+r) + 50/(1+r)2 + … + 50/(1+r)5 + 1,000/(1+r)5

When there is deflation, government reduces interest rates to encourage people to borrow and ensure there is more liquidity in the system. This leads to lowering of r in the above equation. As a result of this, the price of the bonds increase as the denominator goes down.

Thus deflation leads to increase in prices of bonds. So deflation is bullish for the Bonds Market.

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