Question

Suppose financial innovation leads to an increase in junk bond trading, so junk bonds become more liquid.

An investor makes the following remark: "I don't understand the junk bond market. Junk bonds have become more liquid. This should have made them more desirable and increased the demand for them. The increased demand should have driven their yields up, but in fact their yields have gone down. I guess investors just don't value liquidity." Do you agree with the investor's reasoning?

Answer 1

When the yields of the bonds are going down, it will mean that, Bond prices have gone higher and it will be a representation that investor are expecting low yield so that they are factoring in for liquidity of the bonds as they believe that these bonds has grown more safer than they were before and hence they are increasing their Bond price so yields of these bonds are going down.

I DO NOT AGREE WITH THE INVESTOR because when the bond yields will be going down it will be representing that investors are demanding a lower yield as they feel that Bond has become more secured.

It can easily be understood through the bond rating philosophy when the higher credit rated Bond will be paying lower yield and junk Bond will be paying highest yield.

Hence I DO NOT AGREE with the investor.