Econ 311 1nd EditionExam # 1 Study Guide Lectures: 1 - 6Lecture 1 (September 1)I. Economics of Financial Marketsa. Financial Marketsb. Financial IntermediariesII. Monetary Theory and Policyc. Pre-Crisis Worldd. Post-Crisis WorldLecture 2 (September 3) I. Repo ArticleII. Role of the Financial Systema. Provides capitalb. Stores, Protects and provide profitable uses for capitalc. Insures against riskd. SpeculationIII. Structure of Financial Marketsa. 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 Instrumentsa. US treasury billsb. Federal Fundsc. Commercial Paperd. Repurchase Agreements (Repos)Lecture 3 (September 8)I. Interest and Interest Ratesa. Interest – amount lenders receive for extending credit/the amount borrowers pay to obtain creditb. 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)II. Calculating Interest Ratesa. Present Value – the value of an amount in n, years,i.Present Value=Future Value(1+i)nb. Yield to Maturity – interest rate that equates the price of an asset today with the present value of all future payments associated with that assetIII. Four Credit Market Instrumentsa. Simple Loan – borrower receives the principal and repays the principal plus interest at maturityb. Discount Bond – borrower repays face value of the bond at maturity but initially receives less than face valuec. 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 maturityd. Fixed Payment Loan – Borrower makes regular period payments of equal size andeach payment includes both principal and interestLecture 4 (September 10)I. Current Eventsa. Japan and negative interest ratesII. Bond Prices and Bond Yieldsa. BOND PRICES AND INTEREST RATES ARE NEGATIVELY RELATEDb. Formula for bond yield: interest rate=future value− present valuepresent valueIII. Difference Between Yield to Maturity and Rate of Returna. If you hold a bond till maturity then the Yield to Maturity is the Rate of Returnb. 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 Yieldto Maturityii. If the Interest Rate decreases then the Rate of return is more than the Yield to Maturityc. THE LONGER A BONDS MATURITY THE MORE SENSITIVE THE PRICE TO A CHANGE IN INTEREST RATESIV. Real vs. Nominal Interest Ratesa. Real interest rates are the nominal interest rates minus the rate of inflationi. Ex Post Interest Rate:real interest rate=nominalinterest interst rate−actual interest rateii. Ex Ante Interest Rate:realinterest rate=nominalinterest rate−expected interestinflation rate (πe)Lecture 5 (September 15)I. 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 demandII. 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 demandedb. There is a positive relationship between bond price and the quantity of bonds suppliedIII. Increases and Decreases in Bond Demand and Supplya. Increase in wealth increases the demand for bondsb. Decrease in the expected interest rate causes an increase in demand for bondsc. Decrease in the expected inflation causes an increase in demandd. Decrease in the riskiness of bonds relative to other assets causes an increase in bond demande. Increase in bond liquidity relative to other assets causes an increase in bond demandf. Increase in expected profitability of business investments causes an increase in bond supplyg. Increase in expected future inflation causes an increase in bond supplyh. Increase in the government budget deficit causes and increase in bond supplyLecture 6 (September 17)I. Applications of Bond Market Modela. Fisher Effect – “What happens to interest rates when expected inflation increases?”i. Increases in the expected inflation will cause interest rates to riseb. Interest Rates and the Business Cycle – “Are interest rates a Pro-Cyclical or Counter-Cyclical variable?”i. Interest Rates are a Pro-Cyclical variableII. 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 demandedi. Interest is the opportunity cost of holding money instead of bondsb. The Supply of money is determined by the central bank and there for is represented as a vertical line graphicallyIII. Factors that Shift the Demand and Supply of Money in the Liquidity Preference Modela. Increases in income increase the demand for moneyb. Increases in Price Level increase the demand for moneyc. Increases in the money supply decrease the interest rateIV. Effects of an Increase in Money Supplya. Liquidity Effect – if money supply increases then interest rates fallb. Income Effect – if money supply increases the income rise causing the interest rate to risec. Price Level Effect – if money supply increase the price of goods rise which cause the interest rate to rised. Expected Inflation Effect – if money supply increases, inflation expectations increase causing bond prices to rise which causes interest rates to