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Why do increased prices equal lower yields on financial assets?

 
 
Reply Sun 26 Jan, 2014 07:49 pm
From wikipedia, on Quantitative Easing:

"A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions, thus increasing the monetary base and lowering the yield on those financial assets."

Why does the central bank's purchase of financial assets lead to lower yields on them? Is it because the increase in prices means that the returns/yields, already set in terms of previous prices and dollar values, are now less as the value of the dollar has been reduced with the increased money supply? Am I understanding this correctly?

Why does buying short-term government bonds" have the effect of "lowering short-term market interest rates" in "expansionary monetary policy," but "purchasing assets of longer maturity than short-term government bonds" has the effect of "lowering longer-term interest rates further out on the yield curve" in "quantitative easing" policy?

Thanks!
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fobvius
 
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Reply Tue 28 Jan, 2014 01:19 am
@MrAntigone,
http://en.wikipedia.org/wiki/Quantitative_easing

Quote:
Why does the central bank's purchase of financial assets lead to lower yields on them?


Because the increased demand leads to higher prices. The higher the price of a financial asset the lower the yield ( an asset with a coupon of 3% costs 100 if the yield is 3% but if demand pushes the price up to 101 then the yield is lower).

Quote:
Is it because the increase in prices means that the returns/yields, already set in terms of previous prices and dollar values, are now less as the value of the dollar has been reduced with the increased money supply? Am I understanding this correctly?


No.

Quote:
Why does buying short-term government bonds" have the effect of "lowering short-term market interest rates" in "expansionary monetary policy," but "purchasing assets of longer maturity than short-term government bonds" has the effect of "lowering longer-term interest rates further out on the yield curve" in "quantitative easing" policy?



Buying short-term government bonds lowers short-term market interest rates. Buying longer maturity government bonds lowers longer term interest rates.

Buying bonds or other financial assets (whether short term or long term) increases demand and (prices rise/ yields fall).
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