Answer: 1. B. Stock and bond prices will fall
2. D. Stock and bond prices will rise
3. E. Stock prices will fall and bond prices could remam unchanged or rise
Explanation:
1. When interest rates on Government bonds rise, this signifies a general rise in interest in the economy. When interest rates rise, consumers and companies such as the Pharmaceutical Research Company will have to cut back on spending because borrowing is now more expensive. This reduction in spending reduces Investment and therefore profits which will reduce the price of the company stock.
When interest rates rise, it is a standard principle that bond prices drop. This is because bonds pay a fixed rate therefore when interest rates rise, it signifies that bonds are not paying enough and so the demand reduces as people are always looking for better returns which leads to a drop in price.
2. As a result of inflation being less than previously thought, it means that bonds and stocks are providing a better return per dollar because inflation will not erode the value of the returns. When the market realises this they will flock to purchase both stocks and bonds which will lead to a price increase.
3. When there are large swings in the stock market, this signifies Market volatility. Market volatility signifies risk and when this happens risk averse investors will flee from the stock market which will have the effect of reducing the prices of stock as they are sold off. If interest rates on the newly issued Government bonds remain unchanged, people that are fleeing the stock market might invest in the bonds instead which will cause their price to rise as more are bought. However, there is a chance that the investors fleeing might not view the interest rates offered by the government bonds and so will not invest leading to the price of the bonds not changing dude to stable demand.
