Demand for Bonds Essay Example | Topics and Well Written Essays - 1000 words

Demand for Bonds - Essay Example Thus there will be a windfall loss if bonds are purchased. Thus, bond demand will be low. This also implies that if expected future bond prices are high, then the demand for bonds will rise and vice-versa. iv) Expected inflation: Expected inflation has an adverse impact on bond demand. If there is an increase in expected inflation, bond demand will fall and vice versa. v) Relative risk: If the risk associated with a bond increases relative to other assets the demand for that bond will fall. Analogously if there is a decline in the relative riskiness of a bond, its demand will increase. vi) Relative liquidity: If there is an increase in the relative liquidity of a bond, i.e., if converting the bond into cash becomes relatively easier, the demand for it shall rise if other things remain the same and vice versa. vi) Business-cycle movements: If the economy is undergoing a boom, there will be an increase in the demand for bonds. Similarly, the demand for bonds will fall if the economy is suffering a recessionary period. b) Analyse the following statement:   â€Å"This week, the yield on the US Treasury note closed below 3%, a level not seen in 50 years. In the UK, the 10-year Gilt yield sits below 4% for the first time since 1961, according to UBS. Germany’s Bund yield is closing in on 3%. ... This time, the threat of delfation is being taken more seriously. Should policymakers again avert that fate, bond yiels may be primed for an explosive rise as fiscal spending plans and the expansion in money supply suggest inflation is the likely outcome†. [Source: Financial times 28-Nov-2008] Before commenting on the report it will be useful to note that as mentioned above bond demands (and thus investment) are induced by business cycle booms and dissuaded during recessions. However, during booms since the threat of inflation looms large, it is a natural counteracting force to the possibility of overinvestment. Similarly, during recessions, the adverse effect on the demand for bonds can be countered by the threat of deflation. Now, let's turn to the report. The first and foremost point to note in this context is the date of the report. It is dated November, 2008. Thus the US, UK and the German economies were in recession, arguably the worst one since the great depression (This was during the heart of the global financial crisis). Thus, one should expect expansionary monetary policies during this time. Lower interest rates ideally stimulated investment demand and thus increase the effective demand which leads to an expansion in real aggregate output with a multiplier effect and thus employment as well. What is reported seems to be along the same lines of intention. The current yields on US Treasury note fell to a level that was a precedent in 50 years. Similarly there was a decline in long term yields in the UK economy (gilt) and Germany (bund yields). However, in order for this policy to work, the falling bond yields