NISM Certifications · NISM-Series-XV: Research Analyst · Economic Analysis
An economy's central bank buys government securities in the open market through an outright purchase, with all else unchanged. What is the most likely immediate effect?
Banking system liquidity rises and short-term yields tend to fall. The central bank pays for the securities with fresh reserve money, which increases bank liquidity, while its buying raises bond prices and therefore lowers yields.
- ABanking system liquidity rises and short-term yields tend to fallCorrect
- BBanking system liquidity falls and short-term yields tend to rise
- CBanking system liquidity is unchanged because only ownership of securities shifts
- DLiquidity rises but bond prices fall because supply of money exceeds demand
Explanation
When the central bank buys securities it pays with reserve money, which adds liquidity to banks. Greater liquidity and higher demand for securities push bond prices up and yields down. Options saying liquidity falls or that bond prices fall reverse this mechanism.
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