This means that as the price of a bond increases the

Info icon This preview shows pages 4–7. Sign up to view the full content.

View Full Document Right Arrow Icon
governments are willing to borrow more by issuing bonds. This means that as the price of a bond increases, the quantity supplied of that bond will increase. Equilibrium in the Bond Market As you might expect, equilibrium in the bond market occurs at the intersection of the supply and demand curves. At this price and interest rate, the quantity of bonds that borrowers want to issue (supply) is just equal to the quantity that lenders want to purchase (demand). Market equilibrium means there is no shortage or surplus of bonds in the market. Graphically, Figure 6-4 Equilibrium in the bond market P B s i 600 0 400 50 200 B d 200 100 200 300 Q In this example, equilibrium occurs at a price of $400, interest rate of 50%, and at a quantity of 200 bonds. (Please verify that this is the equilibrium from the equations provided.) At a price above $400 there would be a surplus of bonds, and at a price below $400 there would be a shortage of bonds. Only at a price of $400 does the quantity 48
Image of page 4

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Econ 350 U.S. Financial Systems, Markets and Institutions Class 6 supplied equal the quantity demanded. (Of course, these interest rates are unlikely in the United States, but they make the math easier.) Changes in Bond Demand and Bond Supply Increase in demand An increase in demand leads to an increase in the price and quantity of the bond, and a decrease in the interest rate: Figure 6-5 An increase in demand P B d B s i 600 0 400 50 200 B d 200 100 200 300 Q The price increases from 400 to 600 and the quantity increases from 200 to 300. Factors that may cause an increase in demand include an increase in wealth, liquidity, or expected return relative to other assets, or a decrease in the risk of an asset relative to other assets. An increase in supply An increase in supply leads to an increase in the quantity of the bond exchanged and a decrease in the price of the bond or an increase in interest rates. Figure 6-6 An increase in supply P B s i 600 0 400 B s 50 200 B d 200 100 200 300 Q The price decreases from $400 to $200, while the quantity increases from 200 to 300. An increase in the supply of a bond can be caused by an increase in expected profitability of 49
Image of page 5
Econ 350 U.S. Financial Systems, Markets and Institutions Class 6 investment opportunities, an increase in expected inflation, or an increase in government deficits. Note that one important result is that an increase in the government budget deficit, as Bush and Obama have done, will lead to higher interest rates. The Market for Loanable Funds An alternative, but closely related, model of interest rates is the loanable funds market. The loanable funds market: is the market where those with surplus funds are able to lend to those with more productive uses of funds. Those who want them obtain funds by issuing bonds, while those who have them are able to put excess funds to more productive use by purchasing bonds. So the bond market and loanable funds market are closely related: they are the converse of each other. The demand for loanable funds: is equivalent to the supply of bonds. Borrowers demand funds by supplying bonds. An increase in the demand for loanable funds is the same as an increase in the supply of bonds.
Image of page 6

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 7
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern