1 / 33

Understanding the Bond Market: Key Concepts and Dynamics

Explore bond supply and demand, market equilibrium, and factors influencing bond prices and yields. Learn about the Fisher effect, economic shifts' impact, and why bonds carry risks like default, inflation, and interest rate risks.

smccalla
Download Presentation

Understanding the Bond Market: Key Concepts and Dynamics

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. THE BOND MARKET Frederick University 2014

  2. The Bond Market • Bond supply • Bond demand • Bond market equilibrium

  3. Bond supply • bond issuers/ borrowers • look at Qs as a function of price, yield

  4. Bond supply • lower bond prices • higher bond yields • more expensive to borrow • lower Qs of bonds • so bond supply slopes up with price

  5. S Bond price Q of bonds

  6. Bond Demand • bond buyers/ lenders/ savers • look at Qd as a function of bond price/yield

  7. Bond yield Qd of bonds bond demand slopes down with respect to price price of bond Qd of bonds

  8. D Bond price Quantity of bonds

  9. Changes in bond price/yield • Move along the bond demand curve • What shifts bond demand?

  10. Wealth • Higher wealth increases asset demand • Bond demand increases • Bond demand shifts right

  11. P D D Qd

  12. a change in expected inflation • rising inflation decreases real return inflation expected to demand for bonds (shift left)

  13. a change in exp. interest rates • rising interest rates decrease value of existing bonds demand for bonds (shift left) int. rates expected to

  14. a change in the risk of bonds relative to other assets demand for bonds (shift left) relative risk of bonds

  15. a change in liquidity of bonds relative to other assets relative liquidity of bonds demand for bonds (shift rt.)

  16. Bond supply • Changes in bond price/yield • Move along the bond supply curve • What shifts bond supply?

  17. Shifts in bond supply • Change in government borrowing • Increase in government borrowing • Increase in bond supply • Bond supply shifts right

  18. S S’ P Qs

  19. a change in business conditions • affects incentives to expand production supply of bonds (shift rt.) exp. profits • exp. economic expansion shifts bond supply rt.

  20. a change in expected inflation • rising inflation decreases real cost of borrowing supply of bonds (shift rt.) exp. inflation

  21. Bond market equilibrium • changes when bond demand shifts, and/or bond supply shifts • shifts cause bond prices AND interest rates to change

  22. Example 1: the Fisher effect • expected inflation 3%

  23. exp. inflation rises to 4% • bond demand -- real return declines -- Bd decreases • bond supply -- real cost of borrowing declines -- Bs increases

  24. bond price falls • interest rate rises

  25. Fisher effect • expected inflation rises, nominal interest rates rise

  26. Example 2: economic slowdown

  27. bond demand • decline in income, wealth • Bd decreases • P falls, i rises • bond supply • decline in exp. profits • Bs decreases • P rises, i falls

  28. shift Bs > shift in Bd • interest rate falls

  29. Why shift Bs > shift Bd? • changes in wealth are small • response to change in exp. profits is large • large cyclical swings in investment

  30. Why are bonds risky? • 3 sources of risk • Default • Inflation • Interest rate

  31. Default risk • Risk that the issuer fails to make promised payments on time • Zero for government debt • Other issuers: corporate, municipal, foreign have some default risk • Greater default risk means a greater yield

  32. Inflation risk • Most bonds promise fixed interest payments • Inflation erodes the real value of these payments • Future inflation is unknown • Larger for longer term bonds

  33. Interest rate risk • Changing interest rates change the value (price) of a bond in the opposite direction. • All bonds have interest rate risk • But it is larger for the long term bonds

More Related