Learning Path
Question & Answer1
Understand Question2
Review Options3
Learn Explanation4
Explore TopicChoose the Best Answer
A
Lower interest rates generally lead to higher bond prices, especially for low credit risk bonds.
B
Higher interest rates always decrease bond prices, regardless of the credit risk.
C
Bond prices are unaffected by interest rate changes if the credit risk remains constant.
D
Only high credit risk bonds are influenced by central bank interest rate changes.
Understanding the Answer
Let's break down why this is correct
Answer
When a central bank changes interest rates, it directly affects how much money investors can earn from bonds. If the central bank raises interest rates, new bonds will likely offer higher returns, making existing bonds with lower interest rates less attractive. This can lead to a decrease in the prices of those existing bonds because investors will want to sell them to buy the new ones. Conversely, if the central bank lowers interest rates, existing bonds become more appealing since they offer better returns than newly issued bonds, which can increase their prices. For example, if a bond paying 3% interest suddenly competes with new bonds paying only 2%, the price of the 3% bond might go up because it provides a better return for investors.
Detailed Explanation
When central banks lower interest rates, borrowing becomes cheaper. Other options are incorrect because This option suggests that all bonds drop in price with higher rates; This idea assumes interest rates don't matter if credit risk stays the same.
Key Concepts
interest rates
credit risk
central bank policies
Topic
Interest Rates and Bond Prices
Difficulty
hard level question
Cognitive Level
understand
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