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The Three Most Important Things I Learned In This Course

1210 words - 5 pages

In other courses, we have learned about what a bond is. One of the most important things I learned in this class is what affects the supply and demand of bonds, which ultimately decides the price of a bond. Three main items determine the supply of bonds: the expected profitability of investment opportunities, the expected inflation and the government budget. The expected profitability of investment opportunities is important because companies issue bonds to raise money. If a company does not feel that they can make profitable investments with the money they would obtain from issuing a bond they are not going to want to incur the expense (the interest on the bond) and therefore are not going to be as likely to issue a bond. That is part of why you see more bonds for sale during a business cycle expansion than during a recession. The expected inflation influences the supply of bonds because an increase in the expected inflation lowers the real cost of borrowing for a company. If the cost of borrowing money goes down then there are going to be more companies that want to take advantage of what is known as “cheap money”. The government budget is also a large factor in determining the supply of bonds because the U.S. Treasury department issues a large quantity of bonds to fund the government’s budget deficit. The bigger the delta between the government’s expenses and revenue the more money they need to make up this gap and to do this they sell bonds.
Five things determine the demand for bonds; wealth, expected interest rate, expected inflation, riskiness of bonds to other assets and liquidity of bonds compared to other assets. Wealth is referring to how much wealth the general public has. When people have more money to spend, they are going to use some of their discretionary income to make investments, like purchasing bonds. Conversely, when money is tight, such as during a recession, people will have less money to spend and the demand for bonds will go down. The expected interest rate is also an important factor on the demand for bonds. A bond is issued at a set interest rate, so if an investor thinks interest rates are going to be going up in the future that investor is not going to want to buy a bond that will be paying out an amount that is less than the rate that is available in the future. This means that higher anticipated interest rates in the future decrease the demand for bonds and vise versa. The expectation of higher inflation in the future has the same affect as higher interest rates on bonds. If inflation is expected to increase in the future, the demand for bonds will go down because the expected return on the bond will decrease. Risk of the bond affects its demand. A bond is going to be in higher demand if people feel confident that its value will be paid out at maturity. That is part of why U.S. Treasury bonds remain in high demand, they are thought to be no fail bonds as apposed to bonds issued by companies...

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