Econ 311 1nd Edition Exam 1 Study Guide Lectures 1 6 Lecture 1 September 1 I Economics of Financial Markets a Financial Markets b Financial Intermediaries II Monetary Theory and Policy c Pre Crisis World d Post Crisis World Lecture 2 September 3 I Repo Article II Role of the Financial System a Provides capital b Stores Protects and provide profitable uses for capital c Insures against risk d Speculation III Structure of Financial Markets a Debt and Equity markets bonds and stocks b Primary and Secondary markets newly issued and previously issued c Exchanges and Over the Counter markets physical and computerized d Money and Capital Markets short term securities and intermediate long term and equity securities IV Money Market Instruments a US treasury bills b Federal Funds c Commercial Paper d Repurchase Agreements Repos Lecture 3 September 8 I Interest and Interest Rates a Interest amount lenders receive for extending credit the amount borrowers pay to obtain credit II III b Interest Rates reflect to amount of interest paid in relation to the amount lent or borrowed or the trade off between future and present consumption like opportunity cost Calculating Interest Rates a Present Value the value of an amount in n years Future Value Present Value i 1 i n b Yield to Maturity interest rate that equates the price of an asset today with the present value of all future payments associated with that asset Four Credit Market Instruments a Simple Loan borrower receives the principal and repays the principal plus interest at maturity b Discount Bond borrower repays face value of the bond at maturity but initially receives less than face value c Coupon Bond Borrower initially receives the face value of the bond and then makes payments of interest at regular intervals and repays the face value at maturity d Fixed Payment Loan Borrower makes regular period payments of equal size and each payment includes both principal and interest Lecture 4 September 10 I II III IV Current Events a Japan and negative interest rates Bond Prices and Bond Yields a BOND PRICES AND INTEREST RATES ARE NEGATIVELY RELATED future value present value b Formula for bond yield interest rate present value Difference Between Yield to Maturity and Rate of Return a If you hold a bond till maturity then the Yield to Maturity is the Rate of Return b If you sell a bond prior to maturity then the Yield to Maturity could be greater than or less than the rate of return depending on if there is a capital gain or loss change in the interest rate i If the Interest Rate increases then the Rate of Return is less than the Yield to Maturity ii If the Interest Rate decreases then the Rate of return is more than the Yield to Maturity c THE LONGER A BONDS MATURITY THE MORE SENSITIVE THE PRICE TO A CHANGE IN INTEREST RATES Real vs Nominal Interest Rates a Real interest rates are the nominal interest rates minus the rate of inflation i Ex Post Interest Rate real interest rate nominal interest interst rate actual interest rate ii Ex Ante Interest Rate e real interest rate nominal interest rate expected interest inflation rate Lecture 5 September 15 I II III Theory of Asset Demand How will a change in any of the following affect ones decision to buy a particular asset other things equal a Wealth Increase causes increase in asset demand b Expected Return on an asset relative to other assets increase causes increase in asset demand c Risk of an asset relative to other assets decrease causes an increase in asset demand d Liquidity of an asset relative to other assets increase causes an increase in asset demand Model for the Bond Market assumes 1 type of bond and 1 interest rate a There is a negative relationship between bond price and the quantity of bonds demanded b There is a positive relationship between bond price and the quantity of bonds supplied Increases and Decreases in Bond Demand and Supply a Increase in wealth increases the demand for bonds b Decrease in the expected interest rate causes an increase in demand for bonds c Decrease in the expected inflation causes an increase in demand d Decrease in the riskiness of bonds relative to other assets causes an increase in bond demand e Increase in bond liquidity relative to other assets causes an increase in bond demand f Increase in expected profitability of business investments causes an increase in bond supply g Increase in expected future inflation causes an increase in bond supply h Increase in the government budget deficit causes and increase in bond supply Lecture 6 September 17 I Applications of Bond Market Model a Fisher Effect What happens to interest rates when expected inflation increases i Increases in the expected inflation will cause interest rates to rise b Interest Rates and the Business Cycle Are interest rates a Pro Cyclical or Counter Cyclical variable II III IV i Interest Rates are a Pro Cyclical variable Liquidity Preference Model Assume wealth can be held in bonds which earn interest or in money which doesn t a The interest rate is negatively correlated with the quantity of money demanded i Interest is the opportunity cost of holding money instead of bonds b The Supply of money is determined by the central bank and there for is represented as a vertical line graphically Factors that Shift the Demand and Supply of Money in the Liquidity Preference Model a Increases in income increase the demand for money b Increases in Price Level increase the demand for money c Increases in the money supply decrease the interest rate Effects of an Increase in Money Supply a Liquidity Effect if money supply increases then interest rates fall b Income Effect if money supply increases the income rise causing the interest rate to rise c Price Level Effect if money supply increase the price of goods rise which cause the interest rate to rise d Expected Inflation Effect if money supply increases inflation expectations increase causing bond prices to rise which causes interest rates to increases