A company may issue both stocks and bonds which can be a sign of the company’s financial standing in a market. Since investors are risk averse and they would not like to put their money on stocks and bonds of a struggling company, but they would like to put their money on stocks and bonds of a stable and a progressing company. Investors benefit from company’s profit in the form of dividend when they buy a company’s stocks and investors can get higher or lower yield based on the bonds. This is the rationale behind bonds’ and stocks’ prices moving in a same direction. In a bond market, the Interest rates and the price of a bond move in an opposite directions, when the interest rate goes down the price of a bond goes up. The same happens in the stock market, when the interest rate of stocks goes down the price of stocks goes up. Besides the interest rate there are some other factors which can cause the price of stocks to go up or down. One such factor is the growth rate of dividend, when growth rate of dividend goes up the price of stock goes up as well. Additionally, when risk free rate goes down the price of the equity market go down as well, but sometimes even when risk free rate goes down the price of equity market goes up because now risk premium plays a role increasing the prices as risk premium goes up. Supply and demand of bonds and stocks can cause changes in the price of bonds and stocks. When more investors desire to buy a stock than sell it, the price of stocks goes up. The demand for stock is higher than the stock available, which means there is a shortage of stocks in the market. This shortage will cause an increase in the price of stocks because investors will bid higher for the existing stocks and thus drive the price up. In the bond market when people’s wealth go up they have a desire for more bonds and they buy more bonds, increasing their demands for all assets bonds. As bond demand shifts to the right and bond price increase, the interest rate...
Citations: 1: Course Book “Money, Banking, and Financial Markets” Chapter 6,7,8
2: WSJ. “Dow declines 427.47; year 's drop near 40%. Investors fled to the safety of Treasury securities. The yield on the 3-month note fell to near zero.” 11/20/2008
3: Campbell, J., & Ammer, J. (1993). What moves the stock and bond markets? A variance
decomposition for long-term asset returns. Journal of Finance, 48, 3-37.
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