Question

Explain why you would be more or less willing to buy long-term Delta Air Lines bonds under the following circumstances:

a. The company just released its financial statements, indicating that income decreased and liabilities increased.

b. You expect a bull market in stocks (stock prices are expected to increase).

c. You have analyzed your country’s monetary policy and expect interest rates to decrease.

d. Brokerage commissions on bonds fall.

e. Your income and wealth increased over the last two years.

Short answer

Part (a) If bond trading increases, people will be more inclined to acquire long-term corporate bonds.

Part (b) If an investor anticipates a bear stock market, he or she will be more willing to purchase corporate long-term bonds.

Part (c) Long-term corporate bonds would be less appealing.

Part (d) If interest rates are predicted to rise, people will be less likely to buy the bond.

Part (e) Long-term corporate bonds would be less appealing.

Step-by-step solution

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternate asset, according to the theory of portfolio choice.

Explanation to part (a)

If bond trading increases, people will be more inclined to buy long-term corporate bonds since more trading means greater liquidity. Because of the increased liquidity, the investor will be able to convert his bond into cash at any time.

As a result, if bond trading increases, people will be more inclined to acquire long-term corporate bonds.

Explanation to part (b)

If an investor expects a bear stock market, he or she will be more ready to buy corporate long-term bonds because the relative return on bonds will be higher. This means that bonds offer a higher rate of return than equities.

As a result, if an investor anticipates a bear stock market, he or she will be more willing to purchase corporate long-term bonds.

Explanation to part (c)

If the stock brokerage commission reduces, the return on the stock will rise, and people will be less likely to buy long-term corporate bonds because they can now earn more money by buying stock.

As a result, long-term corporate bonds would be less appealing.

Explanation (d)

If a person believes that the interest rate will climb, he will be less willing to purchase the bond. The price of the bond lowers as the interest rate rises, making it a less desirable investment.

As a result, if interest rates are predicted to rise, people will be less likely to buy the bond.

Explanation to part (e)

If the brokerage commission on bonds decreases, the return on the bonds will increase, and as a result, people will be more eager to acquire long-term corporate bonds because they can now earn more money by buying today and selling later.

As a result, long-term corporate bonds would be less appealing.