Question

Your financial investments consist of U.S. government bonds maturing in 10 years and shares in a start-up company doing research in pharmaceuticals. How would you expect each of the following news items to affect the value of your assets?

a. Interest rates of newly issued government bonds rise
A. Stock and bond prices will rise
B. Stock and bond prices will fall
C. Stock prices will fall and bond prices could remain unchanged or rise
D. Stock prices will fall
E. Stock prices will increase
b. Inflation is forecasted to be much lower than previously expected in Recall the Fisher effect Assume for simplicity that this Information does not affect your forecast of the dollar value of the pharmaceutical company's future dividends and stock price
A. Stock prices will fall
B. Stock and bond prices will fall
C. Stock prices will increase
D. Stock and bond prices will rise
c. Large swings in the stock market increase mancalvestors concerns about market risk. (Assume that interest rates on neaty issued government bonds remain unchanged)
A. Stock and bond prices will fall
B. Stock and bond prices will rise
C. Stock prices will fall
D. Stock prices will increase
E. Stock prices will and bond prices could remam unchanged or rise

Answer 1

If interest rates for new bonds rise, existing bond values fall. Lower expected inflation can increase both stocks and bond values. Market volatility can make stocks fall and government bonds more attractive.

Step-by-step explanation:

For question (a), if interest rates of newly issued government bonds rise, the value of existing bonds typically falls because new bonds are more attractive to investors due to their higher yield. Therefore, the correct option is B. Stock and bond prices will fall, since the existing bonds pay a lower interest rate compared to the new ones. However, the impact on the start-up company shares is not as directly related to the change in interest rates, it depends on various other factors including the company's performance and market conditions.

Regarding question (b), if inflation is forecasted to be much lower than previously expected, and the information does not change the forecast of the pharmaceutical company's dividends, this typically leads to an increase in the value of existing bonds because lower inflation preserves the purchasing power of the bond's future cash flows. The correct option is D. Stock and bond prices will rise.

In question (c), large swings in the stock market, which increase investors' concerns about market risk, can lead to a flight to safety. This usually benefits government bonds as they are considered safer investments compared to stocks. In this scenario, stock prices might fall due to increased perceived risk, while bond prices could remain unchanged or rise as they become more desirable. Therefore, the correct option is E. Stock prices will fall and bond prices could remain unchanged or rise.

Answer 2

Answer: 1. B. Stock and bond prices will fall

2. D. Stock and bond prices will rise

3. E. Stock prices will fall and bond prices could remam unchanged or rise

Step-by-step explanation:

1. When interest rates on Government bonds rise, this signifies a general rise in interest in the economy. When interest rates rise, consumers and companies such as the Pharmaceutical Research Company will have to cut back on spending because borrowing is now more expensive. This reduction in spending reduces Investment and therefore profits which will reduce the price of the company stock.

When interest rates rise, it is a standard principle that bond prices drop. This is because bonds pay a fixed rate therefore when interest rates rise, it signifies that bonds are not paying enough and so the demand reduces as people are always looking for better returns which leads to a drop in price.

2. As a result of inflation being less than previously thought, it means that bonds and stocks are providing a better return per dollar because inflation will not erode the value of the returns. When the market realises this they will flock to purchase both stocks and bonds which will lead to a price increase.

3. When there are large swings in the stock market, this signifies Market volatility. Market volatility signifies risk and when this happens risk averse investors will flee from the stock market which will have the effect of reducing the prices of stock as they are sold off. If interest rates on the newly issued Government bonds remain unchanged, people that are fleeing the stock market might invest in the bonds instead which will cause their price to rise as more are bought. However, there is a chance that the investors fleeing might not view the interest rates offered by the government bonds and so will not invest leading to the price of the bonds not changing dude to stable demand.