Consider a struggling emerging-market economy where, in contrast to developed economies, the perceived risk associated with holding sovereign bonds is affected by the state of the economy. Suppose vast quantities of valuable minerals were unexpectedly discovered on government-owned land. How might the government’s bond rating be affected? Using the model of demand and supply for bonds, what would you expect to happen to the bond yields of that country’s government bonds?
If vast quantities of valuable minerals were unexpectedly discovered on government-owned land, this would improve the government’s bond rating. This is because the discovery would likely to lead to higher goverment revenues, higher capacity to repay borrowings, better fiscal position and better trade surplus.
Due to the improved bond rating, the demand for these bonds would increase. This would cause the bond prices to increase, since higher demand without an equivalent increase in supply would cause a price increase.
Due to bond prices increasing, the yields of the bonds would decrease. This is because bond prices and bond yields are inversely related. Higher bond prices mean lower bond yields, and lower bond prices mean higher yields.
Consider a struggling emerging-market economy where, in contrast to developed economies, the perceived risk associated with...
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