Question

Consider a struggling emerging-market economy where, in contrast to developed economies, the perceived risk associated with holding sovereign bonds is affected by the state of the economy. Suppose vast quantities of valuable minerals were unexpectedly discovered on government-owned land. How might the government’s bond rating be affected? Using the model of demand and supply for bonds, what would you expect to happen to the bond yields of that country’s government bonds?

Answer 1

The discovery of huge amount of minerals on government land indicates future earnings for the government and increase in its cashflows.

On such happenings, the government bonds would be considered safer in the sense that the government would be able to repay the bond interest and principal from cashflows received from the mineral reserves. As such, these bonds would be considered more safe and hence their credit ratings would improve.

On improved credit rating, the demands for such government bonds would increase leading to increased price in the market and thereby the yields of the country's government bonds would decrease.