posted by David on .
According to the formula,
Bond price= y/r
so bond price has a inverse relationship with interest rate.i.e. interest rate increases, bond price decreases.
But why does it contradict with this demand-supply anysis: r(interest rate increases)--> returns from buying bonds increase-->cost of holding money increases-->asset demand for money decrease-->supply of bonds decreases-->PRICE OF BONDS INCREASES
what's wrong with the demand-supply anysis, thx!
My logical deduction is: asset demand for money + transaction demand for money= money demand=supply of bond(as bond issuers create supply of bonds)
Because bonds are typically sold with fixed denominations at a set interest rate; say $10,000 at 6%. If interest rates are 6% and the bond pays 6%, then the bond is being sold at par or $10,000. Now say the interest rates rise to 7%. You certainly wouldnt pay 10,000 for the bond. You buy at discount and pay something less.