General Securities Representative (Series 7) Practice Exam

If the US dollar is devalued, what happens to bonds?

1. They increase in price

2. They drop in price

3. They remain stable

4. They become riskier

The correct answer is: They drop in price

When the US dollar is devalued, the general expectation is that bond prices, especially those denominated in dollars, will decrease. This occurs because the devaluation of the dollar means that investors will receive less purchasing power for the interest and principal payments made by those bonds. Consequently, this reduces the attractiveness of the bonds, leading to a decline in their prices. A devalued currency typically also results in higher inflation expectations. As inflation rises, the real returns on fixed-income investments, like bonds, decrease, prompting investors to seek better returns elsewhere, further driving down bond prices. If the currency's value falls, it can lead to concerns about the overall economic stability, which can adversely affect demand for existing bonds. In the context of international investors, the weakened dollar means that returns on dollar-denominated bonds may not be as appealing due to the potential loss in currency value, leading to decreased demand and additional downward pressure on prices. Thus, the rationale for selecting the outcome of a drop in bond prices is well-founded when considering the implications of dollar devaluation.