July 1, 2013 at 6:46 pm #17880
For example, suppose investors view the credit worthiness of 10-year Treasury Securities and 10-year AAA Corporate Bonds the same and the interest rate on both is 2 percent. If the Fed cuts back its purchases of Treasuries their prices will fall and yields increase, say to 3 percent. Investors gain by shifting funds out of Corporate Bonds and into Treasuries. Their arbitrage activity will move the Corporate Bond rate up and the Treasury rate down until they are the same again, but at a higher level than the original 2 percent.