It's known that an increase in the interest rate makes bonds more attractive , so it leads people to hold more of their wealth in bonds as opposed to money , however an increase in the interest rate also reduces the prices of bonds .So, how can an increase in the interest rate makes bonds more attractive and reduce their price?
Sneha KumariBegginer
Above statement is adversely highlighted in the keynesian theory of demand and money. It is implicit , ‘ that rate of interest (i), is really the return on bonds.
He assumes expected return on bonds are of two types-
Market value of bonds is inversely related to rate of interest. The investors compare the current interest rate with ‘normal’ or critical predetermined rates. If rate of current is high compared to normal rate they expect a rise in bond prices and fall in interest rates .
This leads to holding more of bonds as they can earn high returns on it and vice versa.
Therefore, if interest rate increases in near future, bond prices fall, wealth- holder may convert their cash balances into bonds at lower price and have capital gain.