Question

which of the following is true if the price of a discount bond falls? a the spread between the yield-to-maturity and yield-to-call will decrease and the yield-to-maturity will rise. b the spread between the yield-to-maturity and yield-to-call will decrease and the yield-to-maturity will fall. c the spread between the yield-to-maturity and yield-to-call will increase and the yield-to-call will rise. d the spread between the yield-to-maturity and yield-to-call will increase and the yield-to-call will fall.

Answer 1

A fall in the demand for loans and an increase in the supply of loans will lead to declining interest rates, as these conditions enhance competition among lenders and reduce their ability to charge higher rates.

Step-by-step explanation:

When considering the impact on interest rates due to changes in the financial market, there are two primary forces at play: demand and supply. If the demand for credit (loans) falls, there is less competition among borrowers, which in turn gives lenders less power to charge high interest rates. Conversely, if there is a rise in the supply of credit, it means there are more lenders in the market, which increases competition among lenders to attract borrowers. This competition also tends to drive interest rates down. Therefore, both a fall in the demand for loans (b) and a rise in the supply of loans (c) will lead to a decline in interest rates.

A fall in demand signifies that fewer borrowers are seeking loans, which puts downward pressure on the rates lenders can charge. Similarly, an increase in supply indicates that more lenders are offering loans, which also tends to reduce the rates due to the competitive nature of the market. Hence, options b and c are correct because they create conditions where lenders are incentivized to offer more attractive (lower) interest rates to attract customers.