The market rate of interest is 5 per cent. Meera believes it will soon rise to 8 per cent, while Raju believes it will soon fall to 3 per cent. What would each of them do?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Meera sells bonds and holds money; Raju converts money into bonds.
Bond prices move opposite to the rate of interest. Meera expects the rate to rise, so she expects bond prices to fall and a capital loss. She sells bonds and holds money. Raju expects the rate to fall, so he expects a capital gain and buys bonds.
Option (1) Both sell bonds and hold money, to avoid a capital loss. — Incorrect. Only Meera expects a loss. Raju expects a gain.
Option (2) Both convert money into bonds, to make a capital gain. — Incorrect. Only Raju expects a gain. Meera expects a loss.
Option (3) Meera sells bonds and holds money; Raju converts money into bonds. — Correct. Each acts on the expected change in bond prices.
Option (4) Meera converts money into bonds; Raju sells bonds and holds money. — Incorrect. This reverses what each one expects.
NCERT (2026-27): “The Speculative Motive … It follows that the price of a bond is inversely related to the market rate of interest. Different people have different expectations regarding the future movements in the market rate of interest based on their private information regarding the economy. If you think that the market rate of interest should eventually settle down to 8 per cent per annum, then you may consider the current rate of 5 per cent too low to be sustainable over time. You expect interest rate to rise and consequently bond prices to fall. … Under such circumstances, you will try to sell your bond and hold money instead. … When the interest rate is very high everyone expects it to fall in future and hence anticipates capital gains from bond-holding. Hence people convert their money into bonds. …” |