Which of the following pairs of changes is correctly matched?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Higher market rate of interest – Lower bond prices
The price of a bond equals the present value of its returns. A higher rate of interest lowers that present value, so bond prices fall.
Option (1) Higher market rate of interest – More money demanded — Incorrect. At higher interest rates people hold less money, as holding it costs more interest.
Option (2) Higher market rate of interest – Lower bond prices — Correct. Bond prices are inversely related to the rate of interest.
Option (3) Lower market rate of interest – Lower speculative demand for money — Incorrect. A lower rate raises speculative demand, as people expect the rate to rise and fear a capital loss.
Option (4) Higher market rate of interest – Higher bond prices — Incorrect. Bond prices fall when the rate rises.
NCERT (2026-27): “The Speculative Motive … It follows that the price of a bond is inversely related to the market rate of interest. … When interest rate comes down, more and more people expect it to rise in the future and anticipate capital loss. Thus they convert their bonds into money giving rise to a high speculative demand for money. Hence speculative demand for money is inversely related to the rate of interest. …” “3.2.1 Demand for Money … Specifically, when interest rates go up, people become less interested in holding money since holding money amounts to holding less of interest-earning deposits, and thus less interest received. Therefore, at higher interest rates, money demanded comes down.” |