Sept 07, Q3, part iv)

[samuel_von_gudmange]

"The Government of the country is concerned that the local currency is appreciating too fast and decides to introduce immediate controls on transactions by overseas investors.

As a consequence the domestic equity market index has fallen by 15% and
treasury bonds are now yielding 5.25% p.a."

The question states earlier that the yield on treasury bonds was 4.25% before the introduction of the controls, so prices must have fallen.

I'm just making sure I understand why both bonds and equities fell in price. Is it just because of the reduction in demand from foreign investors (many of whom may have been investing in Gilts in order to benefit from the currency appreciation)?

Cheers,



Sam

 

[samuel_von_gudmange]

I think I've got some more answers to this now. It seems quite simple really. I just don't feel too confident about my ideas on this kind of thing.

Bond markets. If currency stops appreciating, the country is more vulnerable to cost-push inflation due to rising costs of imported raw materials such as oil. Higher expected inflation = lower bond prices.

Equity Markets. Possible higher cost of raw materials => worse economic outlook => lower share prices.

Lack of overseas investment => lower prospects for growth, since companies are less able to invest in new projects.

Do these sound reasonable? Any advice would be much appreciated.

Many thanks,



Sam