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2. When the Federal Reserve announces an increase in the federal funds rate, how would bond...

2. When the Federal Reserve announces an increase in the federal funds rate, how would bond prices react to the monetary policy action, i.e., increase, decrease, or stay put?

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Answer #1

When the Federal Reserve announces an increase in the federal funds rate, bond prices will decrease.

Explanation:

Bonds are fixed interest paying securities. Hence, when the interest rate rises in general, the particular bond's rate becomes less attractive in the eyes of the investor. As a result, the demand for that bond decreases. This further leads to a fall in the bond price. (Fall in demand leads to a fall in the value/price of the asset)

The vice versa scenario happens when the interest rate decreases.

Hence, there is an INVERSE RELATIONSHIP between INTEREST RATES AND BOND PRICE.

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