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CP1 Notes - Ch11

D

Darragh Kelly

Ton up Member
Hi,

Just have a couple of questions from the notes from chapter 11.

Page 18 (last sentence):
For example, an decision to increase the use of index-linked bonds might lead to lower prices and higher yields on index-linked bonds and higher prices and lower yields on conventional bonds
I get how an increase in supply of index-linked bonds will reduce price - market flooded with these bonds, so price will come down (law of supply and demand). But not sure why conentional bonds will increase in price (and decrease in yield)?

Page 30:
The level of net cashflow itself will primarily refect the level of saving throughout the economy, whilst the balance between the different institutional investors will reflect the relative popularity of the savings vehicles that they provide.
The net cashflow is the difference how much costumers deposit the bank account and how much bank invests in the market? I'm guessing smaller net balance means a banks savings account is popular? Not quite sure what the statements means.

Page 31:
For example, if a requirement is introduced for institues to value their liabilities using a discount rate no higher than the running yield obtained on investments, then this would increase the relative appeal of investments, such as bonds, with a high running yield.
I'm not really sure what this means...

Thanks very much,

Darragh
 
Hi Darragh

Page 18 question: One possible explanation for this is that lower index-linked bond prices will mean investment losses for those holding these bonds; so they may choose to sell these bonds and invest elsewhere if they want to avoid the possibility of further losses. These investors will then look for alternative investments and may then see that prices for conventional bonds haven't fallen so they may look more safe / attractive. The demand for conventional bonds would then increase relative to the supply, thereby increasing prices and decreasing yields.

Page 30 question: This paragraph is drawing the link between the rate of saving / investment in an economy and potential investors' net cashflow level. Net cashflow is income less outgo. If an investor has a negative net cashflow, it hasn't enough income to cover its outgo and it therefore needs to disinvest rather than invest / save to meet its net outgo, decreasing the level of savings / investment. If an investor has a positive net cashflow, it has more income than is needed to meet outgo and, all else being equal, it will then look to save / invest that excess income, increasing the level of savings / investment.

Page 31 question: Using a higher discount rate to discount liabilities will decrease the (discounted) value of liabilities relative to the assets, improving an institution’s funding / solvency position and thereby making the institution in question look better / stronger. Institutions will therefore often be keen to use discount rates that are as high as possible. In this scenario, investing in assets with a high running yield will allow a high discount rate to be used.

Hopefully that all makes more sense now.
 
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