The Bond Market

Problem 1: Suppose that the economy goes into a recession leading to both a decrease in household wealth and a decrease in the expected profits of investment opportunities for firms. Using the supply and demand model, graphically illustrate and verbally explain the impact of this recession on the price, quantity, and yield of bonds.

Problem 2: Suppose that there is an increase in expected inflation. Using the supply and demand model, graphically illustrate and verbally explain the impact of this recession on the price, quantity, and yield of bonds.

Problem 3: Which bond should sell for a higher price and why? A basic U.S. Treasury bond, which has a $10,000 face value and 20 years to maturity or a U.S. Treasury TIPS bond with the same maturity and face
value?

Problem 4: Suppose your local government decided to tax the interest income on its own bonds as part of an effort to rectify serious budgetary woes. What would you expect to see happen to the yields on these bonds?