Demand of Bonds Point Price of bond Interest rate (i) Demand A $925 (1000 - 925)/ 925 = 8.1% $100 billion B $800 (1000 - 800)/ 800 = 25% $400 billion Table 2: Supply of Bonds Point Price of bond Interest rate (i) Demand A $925 8.1% $400 billion B $800 25 % $100 billion Draw the demand and supply schedules for bonds using: X- axis : $Amount Y- axis: Interest rate Calculate the equilibrium interest rate and dollar amount. Interpret this graph using the Loanable funds theory. Discuss various factors that affect the demand for bonds and supply of bonds.
Do the following exercise with the help of the data provided in the tables below. You will use Excel to create your graphs. In an MS Word file of no more than 1-2 pages, write up responses to the points 2 and 3 below.
Table 1: Demand of Bonds
Point Price of bond Interest rate (i) Demand
A $925 (1000 - 925)/ 925 = 8.1% $100 billion
B $800 (1000 - 800)/ 800 = 25% $400 billion
Table 2: Supply of Bonds
Point Price of bond Interest rate (i) Demand
A $925 8.1% $400 billion
B $800 25 % $100 billion
1. Draw the demand and supply schedules for bonds using:
X- axis : $Amount
Y- axis: Interest rate
2. Calculate the equilibrium interest rate and dollar amount. Interpret this graph using the Loanable funds theory.
3. Discuss various factors that affect the demand for bonds and supply of bonds.
To draw the demand and supply schedules for bonds, we can use the given information on the demand and supply of bonds. We will plot the data points for each demand and supply combination on a graph.
The X-axis represents the dollar amount, and the Y-axis represents the interest rate.
Demand Schedule:
Point A: ($925, 8.1%)
Point B: ($800, 25%)
Supply Schedule:
Point A: ($925, 8.1%)
Point B: ($800, 25%)
Now we can plot these points on a graph, with the dollar amount on the X-axis and the interest rate on the Y-axis.
To calculate the equilibrium interest rate and dollar amount, we need to find the point where the demand and supply curves intersect.
Using the loanable funds theory, we know that the equilibrium interest rate and dollar amount occur where the demand for bonds equals the supply of bonds.
In this case, at the intersection point, the interest rate is approximately 14.3% ($875) and the dollar amount is $325 billion.
Factors Affecting Demand for Bonds:
1. Expected returns on other investments: If other investments offer higher returns, the demand for bonds may decrease.
2. Investor preferences: Changes in risk tolerance or investor preferences for different types of securities can impact bond demand.
3. Economic conditions: Economic indicators like inflation and interest rates can influence bond demand.
4. Government policies: Changes in tax policies or regulations can affect the demand for certain types of bonds.
5. Expectations for future interest rates: If investors anticipate rising interest rates, bond demand may decrease.
Factors Affecting Supply of Bonds:
1. Government borrowing: When governments borrow more, the supply of bonds increases.
2. Economic conditions: Economic stability or growth can impact bond supply.
3. Monetary policy: Actions taken by central banks to control money supply and interest rates can affect bond supply.
4. Fiscal policy: Changes in government spending and taxation can impact bond supply.
5. Expectations for future interest rates: If bond issuers expect interest rates to rise, they may increase the supply of bonds.
By analyzing the graph and understanding the loanable funds theory, we can see that at the equilibrium point, the demand for bonds equals the supply of bonds, resulting in a specific interest rate and dollar amount. This shows the point where lenders and borrowers are willing to trade bonds, balancing the market.
Overall, several factors influence the demand for and supply of bonds, including economic conditions, investor preferences, government policies, and expectations for future interest rates. Understanding these factors is crucial in analyzing and predicting changes in the bond market.