1. If the default risk of corporate bonds decreases, what will happen to the demand for corporate bonds, the price of corporate bonds, the demand for treasuries, and the price for treasuries?
2. Also, explain what direction the demand curve moves for corporate bonds and treasuries (either to the left or to the right).
Bond and Investment risks
Bonds can be a great tool to generate income and are widely considered to be a safe investment, especially compared with stocks. However, investors need to be aware of potential risks to holding corporate and/or government bonds.
Answer and Explanation:
If the default risk of the corporate bonds decreases, it means that the corporates are honoring their due on time. The prices of the corporate bonds will increases and its demand of the corporate bonds also increases as the safety and ranking increases in comparison of the treasuries.
On the contrary, the better performance of the corporate bonds will lead to decrease in the demand of the treasuries which offers lower interest rate to the corporate bonds. The prices of the treasuries if not decrease (being state securities), will remain constant. But the effect of the decrease in the demand could lead to decrease in the price of them also.
The demand curve of the corporate bonds will rise from left to right which means that the demand of the bonds are increasing along with the rise in the price of the bonds and the demand curve of the treasuries, on the contrary, will flow down from left to right showing the decline in the demand and the prices of the treasuries.
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from Finance 305: Risk ManagementChapter 3 / Lesson 8