Kenneth R. Szulczyk
supplying money, i.e. loanable funds. If a business issues bonds, then it demands money, i.e.
loanable funds.- World's interest rate is higher. Thus, investors would loan their surplus funds abroad to earn
the greater interest rate. - World's interest rate is lower. Thus, businesses and the government would borrow the
cheaper funds from foreign investors.
Answers to Chapter 9 Questions
- Investors are usually risk averse. Thus, investors increase their demand for the low-risk
bonds and decrease their demand for the high-risk ones. Consequently, bond prices increase
for the lower-risk bonds but decrease for the higher-risk bonds. Furthermore, the interest
rates are lower for the low-risk bonds and higher for the high-risk bonds. - Investors prefer to hold liquid securities. Thus, investors increase their demand for the
highly liquid bonds and decrease their demand for the low liquid ones. Consequently, bond
prices increase for the liquid bonds but decrease for the non-liquid bonds. Moreover, the
interest rates are lower for the liquid bonds and higher for the non-liquid bonds. - Investors prefer to invest in securities that entail low information costs. Thus, investors
increase their demand for the low information cost bonds and decrease their demand for the
high information cost ones. Consequently, bond prices increase for the bonds with low
information costs but increase for the high information cost bonds. Furthermore, the interest
rates are lower for the bonds with low information costs and higher for the other bonds. - Investors prefer to invest in securities that have lower taxes. Thus, investors increase their
demand for the tax-exempt bonds and decrease their demand for the taxed ones.
Consequently, bond prices increase for the tax-exempt bonds but decrease for the taxed
bonds. Moreover, the interest rates are lower for the tax-exempt bonds and higher for the
taxed bonds. - Term structure of the interest rates is an entity offers a large variety of securities with
different interest rates. Thus, the securities have the same risk, liquidity, information costs,
and taxes. However, the interest rates still differ with long maturity interest rates tend to be
higher than shorter maturities. - Three theories are segmented markets theory, expectations theory, and preferred habitat
theory. Segmented markets theory is investors prefer to invest in specific bond markets, and
each bond market has its own supply and demand. Expectations theory is for investors to
invest in longer-term securities; they expect the interest rate to be greater, causing a
positively sloping yield curve. Preferred habitat theory is investors prefer a certain bond.