Question
Assume there is an increase in risk associated with government bonds due to congress threatening to default on government debt. Also assume this change in
Assume there is an increase in risk associated with government bonds due to congress threatening to default on government debt. Also assume this change in policy only affects the lenders willingness to hold government debt (the Bond Demand Schedule) in your in your analysis.
a. Use a Bond Supply and Demand diagram to demonstrate what happens to the price of government bonds following this change in policy. Explain the shift in the appropriate curve (identify the shock to the market).
b. Explain what happens to the equilibrium yield to maturity on government bonds.
c. Use a Bond Supply and Demand diagram to demonstrate what happens to the price of corporate bonds following this change in policy (the threat of default on government debt). Also assume this change in policy only affects the lenders willingness to hold corporate debt (the Bond Demand Schedule) and there is no change is risk on corporate bonds.
d. Explain what happens to the equilibrium yield to maturity on corporate bonds.
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