Beet
Atlas Star
Posts: 28,914
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« on: July 15, 2010, 04:28:24 PM » |
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Discuss the factors that determine the Supply and Demand of bonds at a given duration.
Assume movement long the curves is determined by bond price (yield), the y axis, and quantity, the x axis.
What factors primarily shift the curves? Demand side: Credit Risk- the risk of capital loss through default. As credit risk rises, the demand curve shifts downward. The cost of substitutes- the opportunity cost. As interest rates rise in general, the demand curve shifts downward as investors move to other bonds or investments. This includes bonds by the same issuer of a different maturity. Inflation Risk- the risk of capital loss through inflation. As inflation expectations rise, the demand curve shifts downward because the present value falls. Total wealth- As savings increase, demand increases and interest rates fall. But how is this measured? What is meant by 'total wealth'? And what exactly is 'savings'?
Supply side: Government policy- If governments choose to run deficits, supply rises, and prices fall. Supposedly the 'crowding out' effect conservatives love to whine about. But this has not happened. For example, look at US and Japanese interest rates. Return on physical capital- As the return on capital increases, firms borrow more to buy capital, issuing bonds. Consumer demand- As consumers demand more consumption, demand for borrowing rises. Securitization- As regulations fall away, a greater amount of loans can be originated and securitized. This increases the supply of bonds for offer as borrowing demand rises.
What else?
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