If fluctuations in interest rates become smaller, then, other things equal, the demand for stocks _ and the demand for long-term bonds _

Economics Dec 13, 2020

If fluctuations in interest rates become smaller, then, other things equal, the demand for stocks _____ and the demand for long-term bonds _____.

A. decreases, increases

B. increases, increases

C. increases, decreases

D. decreases, decreases

Expert Solution

Answer: A

One of the risk of holding long-term bonds is that the interest rate and inflation move against your investment and reduce its value. For example, assume you buy a bond at 4% but then interest rates rise to 6%. Your bond is now worth less. Thus, the more stable interest rates are, the more attractive long-term bonds. Since bonds and stocks are substitutes, the more bonds become attractive, the less demand for stocks will be.

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