A Wall Street Journal offered the following opinion of the bond market in September 2012, when inflation rate was about 2%: “Someone buying long-term bonds yielding 1.5% or 2% and then seeing consumer price inflation of 4%, will be on the losing end of the bet”.

a. Explain verbally and illustrate graphically what will happen to the price of bonds if expected inflation increases to 4% from 2%. Be sure to include in your answer the demand the bond market.

b. Explain why someone buying long-term bonds yielding 1.5% or 2% and then seeing consumer price inflation of 4%, will be on the losing end of the bet.

c. Suppose that you expect a greater increase in inflation than do others investors, but that you do not expect the increase to occur until 2015. Should you wait until 2015 to sell your bond? Briefly explain.

d. The columnist also argued that long-term bonds would be a good investment if only “ when we get serious price deflation”

1. Explain verbally and illustrate graphically the effect on bond price if investors decide that price deflation is likely to occur. Be sure to include in your answer the bond market.

 2. Explain verbally why long-term bonds would be a good investment if only “ we get serious price deflation”

e. If expected inflation is increasing, would you have made a worse investment if you had invested in long-run bonds than if you had invested in short-term bonds? Explain