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Term structure Chapter 14 Q14.10

A

actuary111

Member
For those who have done economics before, if we plot the demand and supply curves on a set of Price-Quantity axis, the demand curve is the downward sloping one and the supply is the upward sloping one. Right?

I can't see why in Q14.10, in the solutions it is stated that if demand falls, the price will also fall (I believe the price will increase as we are moving to the left of the demand curve).

And similarly, I can't see why they say that if supply increases, the price falls (according to the plot described above, the price will increase).

Does anyone know the logic behind ActEd's answers to this question in the notes? Are the relationships of Demand and Supply with price different for fixed interest bonds to the standard Demand and Supply plot?

Thank you
 
Hi,

Not sure if you're still looking for an answer, but here's my take on it.

You are correct about curves, but here I think we interpret the increase in demand as an upward shift of the demand curve, I.e. higher quantity demanded at every level of price. This reflects an exogenous change in demand - perhaps risk has changed for other investments making bonds more desirable. The result is higher equilibrium price and hence lower yields. Same for reduction in demand, but in reverse.

Good luck for next week.
 
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