In recent days we have observed falling government bond yields in most non-EMU nations which suggests that investors are viewing sovereign debt less favourably since the downgrading of the US rating.
Answer: False
The answer is False.
In macroeconomics, we summarise the plethora of public debt instruments with the concept of a bond. The standard bond has a face value - say $1000 and a coupon rate - say 5 per cent and a maturity - say 10 years. This means that the bond holder will will get $50 dollar per annum (interest) for 10 years and when the maturity is reached they would get $1000 back.
Bonds are issued by government into the primary market, which is simply the institutional machinery via which the government sells debt to "raise funds". In a modern monetary system with flexible exchange rates it is clear the government does not have to finance its spending so the the institutional machinery is voluntary and reflects the prevailing neo-liberal ideology - which emphasises a fear of fiscal excesses rather than any intrinsic need.
Once bonds are issued they are traded in the secondary market between interested parties. Clearly secondary market trading has no impact at all on the volume of financial assets in the system - it just shuffles the wealth between wealth-holders. In the context of public debt issuance - the transactions in the primary market are vertical (net financial assets are created or destroyed) and the secondary market transactions are all horizontal (no new financial assets are created). Please read my blog - Deficit spending 101 - Part 3 - for more discussion on this point.
Further, most primary market issuance is now done via auction. Accordingly, the government would determine the maturity of the bond (how long the bond would exist for), the coupon rate (the interest return on the bond) and the volume (how many bonds) being specified.
The issue would then be put out for tender and the market then would determine the final price of the bonds issued. Imagine a $1000 bond had a coupon of 5 per cent, meaning that you would get $50 dollar per annum until the bond matured at which time you would get $1000 back.
Imagine that the market wanted a yield of 6 per cent to accommodate risk expectations (inflation or something else). So for them the bond is unattractive and they would avoid it under the tap system. But under the tender or auction system they would put in a purchase bid lower than the $1000 to ensure they get the 6 per cent return they sought.
The mathematical formulae to compute the desired (lower) price is quite tricky and you can look it up in a finance book.
The general rule for fixed-income bonds is that when the prices rise, the yield falls and vice versa. Thus, the price of a bond can change in the market place according to interest rate fluctuations.
When interest rates rise, the price of previously issued bonds fall because they are less attractive in comparison to the newly issued bonds, which are offering a higher coupon rates (reflecting current interest rates).
When interest rates fall, the price of older bonds increase, becoming more attractive as newly issued bonds offer a lower coupon rate than the older higher coupon rated bonds.
Further, falling yields indicate that the demand for bonds is rising which suggests that investors are viewing them more favourably (relative to other investment products).
The following blogs may be of further interest to you:
Premium