If interest rates are expected to fall in the future, then today the demand for long-term bonds will ________ and the curve shifts to the ________:

Question

BlackTom AI · Accepted Answer

Bond prices increase when interest rates fall, so if rates are expected to decline in the future investors anticipate capital gains on existing long-term bonds and will demand more of them today.

1) Relevant knowledge points and concepts
- Bond price and yield are inversely related: when market interest rates (yields) fall, existing bond prices rise because their fixed payments are discounted at a lower rate.
- Expectations matter: expected future decreases in interest rates create an expected future price increase for currently held bonds, making them more attractive today.
- A demand curve shift to the right means an increase in demand at every price; a left shift means a decrease.

2) Step-by-step reasoning
- Investors compare current purchase returns to expected future returns. If future rates are expected to be lower, the present value of a bond’s payments calculated at those lower rates would be higher.
- Therefore, buying a long-term bond today yields an expected capital gain when rates fall, increasing the attractiveness of holding long-term bonds now.
- Increased attractiveness raises the demand today for long-term bonds, shifting the demand curve to the right.

3) Calculation example (intermediate steps)
- Consider a simple one-year bond paying $100 at maturity.
- If current interest rate r0 = 5%: price today P0 = 100/(1 + 0.05) = 100/1.05 = 95.238.
- If expected future rate r1 = 2%: future price P1 = 100/(1 + 0.02) = 100/1.02 = 98.039.
- Expected capital gain = P1 − P0 = 98.039 − 95.238 = 2.801, which motivates buying today.

4) Why the correct answer is correct
- Because expected falling rates imply expected future price increases for long-term bonds, investors demand more now. That is precisely an increase in demand and a rightward shift in the demand curve.

5) Why the other options are incorrect
- b (fall; left): contradicts the expectation-driven incentive—demand would rise, not fall.
- c (rise; left): self-contradictory—cannot both rise in level and shift left.
- d (fall; right): implies demand falls but the curve shifts right; inconsistent with the logic that expected rate falls raise demand.

6) Conclusion
- The demand for long-term bonds will rise and the demand curve shifts to the right. This matches answer a.

If interest rates are expected to fall in the future, then today the demand for long-term bonds will and the curve shifts to the :Single choice

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If interest rates are expected to fall in the future, then today the demand for long-term bonds will ________ and the curve shifts to the ________:Single choice