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Chapter 5: Q.8 (page 164)

What will happen in the bond market if the government imposes a limit on the amount of daily transactions? Which characteristic of an asset would be affected?

Short Answer

Expert verified

The attribute that will be impacted by the government's choice is liquidity.

Step by step solution

01

Introduction

Liquidity is defined as the ease with which an asset or security can be turned into money and vice versa. Because it has the power to influence product demand, liquidity is one of the most important features of an asset.

02

Explanation

If the government places limits on the number of daily transactions that can be made in the bond market, the bond's liquidity will be reduced. If the bond's liquidity is reduced, demand for the bond falls, lowering the bond's price.

Bond demand will fall as investors prefer more liquid assets to less liquid assets, and as the bond market becomes more constrained, investors will seek for more liquid security. The attribute that will be impacted by the government's choice is liquidity.

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