Liquidity Trap and bonds price

As some students are confused on questions regarding liquidity trap, so let me clarify

In case of liquidity trap, the interest rate comes down to almost zero. So, if new bonds are issued at time of liquidity trap situation in the economy then the interest rate offered on the bonds will be almost zero (or very less) and hence the yield will also be almost zero.

But, the previous bonds which were issued let us say 3 years back at an interest rate of 5%, these bonds price would go up (in the secondary market) once the economy moved into liquidity trap and interest rate came down to zero. And the yields on these bonds will also be almost zero because the present interest rate is almost zero and bond prices have moved up.

So, there are two aspects of bonds. One is the issuance of new bonds and the other is the already issued bonds being traded in secondary market. And when we talk about the bonds its basically the bonds being traded in secondary market.

When a new bond is issued then there is no sense of talking about its price because you can issue the bond at any price i.e. Rs. 1, Rs. 10, Rs. 100 etc.

Its the already issued bonds which are being traded in secondary market and their price increases or fall and hence yield falls or increases.

Explanation

External Commercial Borrowings (ECBs) are commercial loans/debt raised by resident entities from recognised non-resident entities. So, it is basically debt denominated in foreign currency or Indian rupee and includes:

1. Bank Loan

2. Trade Credits: 

It refers to the credits/loan extended by the overseas supplier, bank, financial institution and other permitted recognised lenders for imports (into India) of capital/non-capital goods permissible under the Foreign Trade Policy of the Government of India. Depending on the source of finance, such Trade Credits are called suppliers’ credit and buyers’ credit.  

3. Bonds, Debentures which should not have condition of fully/compulsorily convertibility. 

Bonds/debentures are basically debt but some have option to convert into shares/equity. So, only those debentures/bonds which does not have a condition of fully/compulsorily convertibility are treated as ECB. 

4. Preference Shares which should not have condition of fully/compulsorily convertibility: 

Preference shares have basically preferential rights over dividend and to repayment of the capital in the case of winding-up of the company. Some preference shares have option of conversion into equity shares after some time. So, in ECB only those preference shares are included which does not have fully/mandatorily convertibility condition. Actually preference shares.....their features are like bonds for example preferential rights over dividend (a kind of fixed income) and priority over repayment of capital in case of bankruptcy. These characteristics make them a part of ECB but they should not have condition of fully/mandatorily conversion into normal/common equity shares.