study guide for exam 1
study guide for exam 1 Econ 3303-001
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This 17 page Study Guide was uploaded by IHUOMA ECHENDU on Wednesday February 17, 2016. The Study Guide belongs to Econ 3303-001 at University of Texas at Arlington taught by kathy kelly in Winter 2016. Since its upload, it has received 251 views. For similar materials see money and banking in Economcs at University of Texas at Arlington.
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Review Sheet for Exam 1 spring 2016. Chapter 1 Financial Markets: Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage. Why Study Financial Markets: •Promote economic efficiency by channeling funds from savers to investors (individuals that will put funds to productive use) •Impact the personal wealth of consumers •Impact the behavior of businesses. Examples of financial markets: Bond Market: A bond is a debt security that promises to make payments periodically for a specified period of time. IOU. The market where interest rates are determined. Company’s borrow from me to finance their activities and pay back with interest. INTEREST RATE: the cost of borrowing or the price paid for the rental of funds. They affect the way we borrow and lend money. E.g. car loan rates, mortgage interest rates etc. Interest rates tend to move in unison, however, interest rates on different types of bonds can vary substantially. *government bonds are default risk free *risk require compensation *longer term bonds have more interest rate risk *high inflation = high interest rates (they go hand in hand) Stock Market: The stock market (aka common stock) is the most widely followed financial market. A share of stock is a share of ownership in a corporation. It’s an equity market. It is a security that’s a claim on the earnings and assets of the corporation. *Stock market prices are often volatile. *How do changes in the stock market affect business investment decisions? The price of the shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. *How can changes in the stock market affect consumer decisions to spend? Fluctuations in stock prices affect the size of people’s wealth and as a result may affect their willingness to spend. E.g. when stock prices fall an individual’s wealth may decrease as well as their willingness to spend may decrease. Why Study Financial Institutions: they make financial markets work, without them financial markets wouldn’t be able to move funds from savers to people who have productive investment opportunities. Financial intermediaries – institutions that channel funds from savers to investors. Banks are the largest financial intermediaries in the economy. Financial crises – major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms. Unanticipated occurrences. Financial innovation development of new financial products and services. It sometimes lead to financial crisis when poorly managed. Banks are the source of rapid financial innovations. Money/money supply: anything that is generally accepted in payment for goods and/or services or in the repayment of debts. It’s a medium of exchange. Business cycle: the up and down movement of aggregate output in the economy. It is measured from peak to peak. How does the money growth rate relate to the business cycle? Money growth rate declines prior to a recession. Aggregate Price level/price level: the average price of goods and services in an economy. Inflation: the continual increase in the price level. It affects individuals, business and government. Maintaining it at 2% is good. *During an inflation just the average prices are going up not all prices. *deflation is the opposite of inflation. It’s bad for the economy. It makes it more difficult to pay back debt, causes unemployment, increases inventory and reduces purchases. *japan is going through a deflation/depression. *disinflation is the decrease in the inflation rate. Interest rate also goes down. Could be a good thing. How does the money growth rate relate to inflation? If you grow money too rapidly for a long time it will lead to an inflation, they go hand in hand (positive relationship). But keeping money growth rate in check doesn’t necessarily guarantee NO INFLATION. Monetary Policy: the management of the money supply and interest rates. What organization in the U.S. is responsible for conducting monetary policy? Federal Reserve (central bank). Fiscal Policy: decisions about government spending and taxation. What group in the U.S. is responsible for conducting fiscal policy? CONGRESS What is a budget deficit? Excess government expenditures over tax revenues for a particular time period, usually a year. Not bringing in enough money to cover expenses. We are currently running a budget deficit. What is a budget surplus? Bringing in more revenue than expenses (tax revenue exceeds government expenditures). Foreign Exchange Market: the market where one currency is converted into another currency. E.g. from naira to dollar. The exchange rate market is a volatile and floating market. U.S.A. system more of a managed float. How can exchange rate fluctuations affect U.S. consumers and businesses? *appreciation: if a country’s currency can buy more of another country’s currency, we say it has appreciated. *depreciation: the opposite of appreciation (advantage to exporters typically) *strong dollar: benefits importers *weak dollar: benefits exporters (other countries get to buy more goods from us to their advantage). * If you plan to travel to Europe next summer, do you want a weak dollar or a strong dollar? Why? STRONG DOLLAR BECAUSE YOU CAN BUY MORE. GROSS DOMESTIC PRODUCT (GDP) – the market value of all final goods and services produced in a country during a specified time period (usually a year). Nominal GDP- GDP calculated using current prices. Real GDP- GDP calculated using constant prices. Growth Rate- percentage change in a variable [(ending – beginning)/beginning] x 100 Understand questions 2, 3, 15, 16: 2. What effect might a fall in stock prices have on business investment? A fall in stock prices will most likely cause a business to postpone undertaking an investment project. The business will not receive as much if they chose to issue new stock. 3. What effect might a rise in stock prices have on consumers’ decisions to spend? When stock prices increases, stock owners see an increase in wealth and so are more like to increase consumption expenditures. In addition, an increase in stock prices increases overall consumer confidence in the economy and thus, we will see an increase in consumption spending overall. 15. How does a fall in the value of the pound sterling affect British consumers? British consumers will find that imports cost more than before the pound sterling fell in value. 16. How does an increase in the value of pound sterling affect American businesses? American businesses will find it easier to sell their products in Britain. If, however, you are a business that relies on importing merchandise from Britain, you will find it is more expensive than before the pound went up in value. Chapter 2 Function of financial markets: •Channel funds from savers to borrowers •Improves economic efficiency Flow of funds: Direct finance: borrowers borrow funds directly from lenders in financial markets by selling them securities. Example – Purchasing a bond issued by Ford Motor Company. SAVER TO BORROWER. Indirect finance: using a financial intermediary to channel funds from savers to borrowers. Example – Purchasing shares in a mutual fund. SAVER TO FINANCIAL INTERMEDIARIES TO BORROWER. Structure of financial markets: Debt Market: contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date when a final payment is made. IOU. MATURITY: number of time periods (term) until that instrument’s expiration date. Stocks don’t have maturity dates. LONG-TERM: debt with a maturity date of ten years or longer. Example – mortgage (15-30 years is the most common), treasury bonds. INTERMEDIATE-TERM: debt that matures in one to ten years. Example – car loan, treasury notes (2, 3 or 7 years). SHORT-TERM: debt that matures in less than a year. Example – Treasury bill (3, 6, or 12 months). Equity Market: claims to share in the net income and the assets of a business. Dividends – payments to the shareholders. They aren’t guaranteed, one has to make profit first. Your share of profit in stock is a dividend. Residual claimant -- the right of the stockholder to whatever remains after all other claims against the firm's assets have been met. Primary Market: financial market in which new issues of a security are sold to initial buyers. The corporation acquires new funds here. First time stocks and bonds are issued here. What financial institution assists in the initial sale of securities? ANSWER-INVESTMENT BANKS Secondary Market: financial market in which securities that have been previously issued can be resold. The owner of the security receives funds here. E.g. New York stock exchange. This is a market for previously purchased securities. Functions of secondary markets •make financial instruments more liquid/easy to resell •determine the prices for securities sold in the primary market Organization of Secondary Markets Exchange: buyers and sellers of securities meet in one central location to conduct trades. Example – NYSE Over-the-counter: dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their prices. Example – U.S. government bond market. Money Market: a market in which only short-term debt is traded (has nothing to do with actual money). Money Market Instruments •U.S. Treasury Bills •Negotiable CDs (certificate of deposits) •Commercial paper: issued by large corporations •Repurchase agreements: used by banks •Federal funds: loans from a bank to a bank Capital Market: the market in which longer-term debt and equity instruments are traded. Capital Market Instruments •Corporate stock: no maturity date •Mortgages and mortgage-backed securities •Corporate bonds: 30 year bonds •U.S. government securities •U.S. government agency securities •State and local government bonds/municipal bonds: 30 years •Consumer loans •Bank commercial loans International Financial Markets Foreign bond: a bond sold in a foreign country and denominated/priced in that country’s currency/legal tender. Example – GM bond sold in London in pounds sterling Eurobond: a bond denominated in a currency other than that of the country in which it is sold. It isn’t always denominated in terms of the euro currency. Example – GM bond sold in London in dollars Eurodollar: U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches of U.S. banks Function of Financial Intermediaries Reduce transactions costs: Transactions costs are the time and money spent carrying out financial transactions. Financial intermediaries can reduce transactions costs through economies of scale. Risk sharing: Financial intermediaries help individuals to diversify and reduce risk. Asymmetric information. One party to a negotiation has more information than the other party to the negotiation (not the same on both sides). Adverse Selection is the asymmetric information problem created before the transaction occurs. Those individuals most likely to produce an adverse outcome are the individuals most actively seeking the transaction. E.g. those who are more likely to borrow money are also more likely not to pay back. Moral Hazard is the asymmetric information problem created after the transaction occurs. Individuals change their behavior after the transaction takes place. Economies of Scope: using one resource to provide many different products and service. Can lead to a conflict of interest problem. Types of Financial Intermediaries Depository Institutions – Financial intermediaries that accept deposits from individuals and institutions and make loans. Examples Commercial banks: e.g. chase (most used) Savings and Loan Associations: similar to commercial banks Mutual Saving Banks: anyone can join, no dividends. Credit Unions: there’s a commonality; interest rates may be lower than commercial banks. Contractual Savings Institutions – Financial intermediaries that acquire funds at periodic intervals on a contractual basis. Examples Life insurance companies: invest in longer term assets Fire and casualty insurance companies: have shorter term assets because they are less likely to predict future casualties unlike life insurance companies. Pension funds and government retirement funds: you get to decide where this goes. Investment Intermediaries— other types of financial intermediaries. Examples Finance companies: make loans and don’t accept deposits. Mutual funds Money market mutual funds: short term debt Hedge funds Reasons for regulation of the financial system 1. To increase the information available 2. To ensure the soundness of the financial system Indirect or Direct? You purchase a united states government bond at treasurydirect.gov – DIRECT You deposit $10000 into your savings account at Wells Fargo bank and your friend Rachel borrows $10000 from Wells Fargo to buy a car- INDIRECT. (Understand question 4) 4. If you suspect that a company will go bankrupt next year, which would you rather hold, bonds issued by the company or equities issued by the company? Why? I would prefer to hold a bond. Bonds are debt and all debt must be paid before the owners (shareholders) receive the residual. Chapter 3 Money definition: anything that is generally accepted in payment for goods and services or in the repayment of debts. Medium of exchange. Income – a flow of earnings per unit of time. You must attach a time period for this measure. “Janet earns $200.00.” Wealth – The total collection of pieces of property that serve to store value. Wealth is a stock variable, i.e. measured at a point in time. Difference between money, income, wealth: Which of the following statements uses the term “money” correctly? 1. Jill earns a lot of money at her new job. She is making $200.00. INCOME 2. Jerry Jones has a lot of money. WEALTH 3. The textbook for this class cost a lot of money. MONEY Flow variable: a time period is attached to it e.g. income Stock variable: measured at a point in time e.g. wealth and money supply Functions of money: Medium of exchange: money makes trade easier and less time consuming unlike barter. Avoids the problem of the double coincidence of wants. Money lowers transactions costs. Unit of account: money is used to make decisions on what to buy if an item is weighed with price. Used to measure value in the economy. Store of value: money is received on the note that it can be kept and used for later purposes. Way of saving for future expenses. Characteristics of money: 1. Easily standardized: it should be easy to figure out the value 2. Widely accepted: stores and other places should be able to take it. 3. Divisible: could be broken down into lesser value (change). 4. Portable: easy to carry around 5. Not deteriorate quickly: last long without needing a replacement 6. Hard to counterfeit: in order for money to maintain security and inability to illegally duplicate. Liquidity: the relative ease and speed with which an asset can be converted into a medium of exchange. Money is the most liquid asset. History of payments system: anything that has made transactions easy and less costly are accepted Barter: goods and services are exchanged directly for other goods and services. For barter to work there has to be double coincidence of wants. Commodity Money: money that has a purpose other than just as money. Precious metals, coins made from precious metals, gold silver, cigarettes etc. Fiat Money: money that is intrinsically worthless. Paper currency decreed by governments as legal tender but that is not convertible into precious metals. Checks: an instruction from you to your bank to transfer funds from your account to someone else when the check is presented. Checks can be cancelled if lost (it’s safer) unlike paper currency which when lost may or may not be able to be retrieved because there is no proof of ownership. Electronic Money/E-payments: transfer of funds electronically without the use of paper. This is faced with security problems but is becoming more acceptable. E-money has risen due to current generation. Will the U.S. become a cashless society? Measuring Money The Federal Reserve is responsible for measuring the money supply and reports on the monetary aggregates every week (Thursdays). Monetary aggregates: M1: directly spendable money/narrow money/ transactions money. • Currency • Traveler’s Checks • Demand Deposits/checking account • Other checkable deposits *A credit card isn’t part of m1 because it’s a loan and not a final payment/transaction. *debit card is in m1 *savings account= m2 M2: may or may not be directly spendable • M1 • Smalldenomination time deposits • Savings deposits and money market deposit accounts • Money market mutual fund shares A CASE WHERE M1 AND M2 DECREASE: if you use currency to purchase a Tbill (currency reduces on both sides) none increases. Do the two measures of money always move in the same direction? No they don’t What does this mean for policymakers? This makes it difficult to predict what is going on with the money supply and makes it hard for policymakers to decide the right course of action. (Understand question 15): For each of the following assets, indicate which of the monetary aggregates includes them: a. Currency: M1 and M2 b. Money market mutual funds: M2 c. Smalldenomination time deposits: M2 d. Checkable deposits: M1 and M2 EXAMPLES OF M1 AND M2 (INCREASE OR DECREASE): Transfer funds from checking account to your money market mutual funds account: M1 decreases, m2 stays the same. You redeem your time deposit and put the funds into your checking account: m1 increases, m2 stays the same. You use funds from your savings account to purchase a time deposit: m1 and m2 stay the same. You use funds from your checking account to purchase a U.S. treasury bill: m1 and m2 decrease. You deposit the currency in your pocket into your checking account: M1 and m2 stay the same. Chapter 4: Present value: Today’s value of a payment to be received in the future when the interest rate is “i”. Note that the higher the interest rate the lower the present value. Also, the longer the time period the lower the present value. Why is a dollar you receive today more valuable to you than a dollar you might receive a month from now? Because it can be saved and invested. Types of credit market instruments Simple loan: a credit market instrument providing the borrower with an amount of funds that must be repaid to the lender at the maturity date along with an additional payment (interest). Onetime payment loan. For a simple loan, the simple interest rate equals the yield to maturity. Fixedpayment loan: a credit market instrument that provides a borrower with an amount of money that is repaid by making a fixed payment periodically for a set number of years. E.g. car payment. Continuous payment till maturity date. Coupon bond: a credit market instrument that pays the owner of the bond a fixed periodic every year until the maturity date when a specified final amount is repaid. Maturity date/Term: the date the loan expires or when the final payment must be paid. Par (face) value: the final specified amount that is paid to the owner of a coupon bond at the maturity date. Coupon rate: the percentage of the par value that is paid to the bondholder on a regular basis. It is set the first time the bond is sold in a primary market it never changes once set. What might change is the price one is willing to pay. Unlike interest rate, coupon rate is fixed. Coupon payment: the periodic payment the holder of the coupon bond receives. It is calculated by multiplying the coupon rate times the par value. Discount bond (zerocoupon bond): a credit market instrument that is bought at a price below its face value and whose face value is repaid at the maturity date. It does not make any periodic payments. Yield to maturity: the interest rate that equates the present value of a debt instrument’s cash flow payments to today’s value. You must collect final payment for an amount to be your interest earned for holding on to it for that time period. Relationship between price & yield: Bond prices and yields are inversely (negatively) related. When bond price goes up, the yield to maturity decreases. The yield to maturity is equal to the coupon rate when the bond price is equal to the par value. Consol/perpetuity: a bond with no maturity date and no repayment of principal that pays fixed coupon payments forever. Current yield: The formula for the yield to maturity of a perpetuity is often used to approximate the yield to maturity for a long-term coupon bond. When used in this manner, the calculation is called the current yield. Rate of return: payments to the owner of a security plus the change in the security's value, expressed as a fraction of its purchase price. The return on a security is not necessarily equal to the yield to maturity of that security. Key findings: If a bond is held to maturity, the return equals the initial yield to maturity. An increase in interest rates means a decrease in bond prices and a capital loss for bonds not held to maturity. The longer the time to maturity the larger the bond's price change when the interest rate changes. The longer the time to maturity the larger the change in the rate of return when the interest rate changes. Even a bond with a high initial yield can have a negative return if interest rates rise. *Current bond prices and interest rates are negatively related. When interest rates rise, bond prices fall. When bond prices are rising, interest rates are falling. *All bonds have interest rate risk including U.S. treasury bonds *U.S. treasury are default risk free. They aren’t totally risk free. They have interest rate risk. *One could suffer a loss if sold before maturity date. *All kinds of risk require compensation Interest rate risk: the possible reduction in returns associated with changes in interest rates. Prices and returns for longterm bonds are more volatile than those for shorterterm bonds. Nominal interest rate: current or market interest rate. They are stated on your loan contract. They don’t drive borrowing and lending. Real interest rate: nominal interest rate adjusted for expected changes in the price level. Drives borrowing and lending in the economy. When the real interest rate is low, there are greater incentives to borrow and fewer incentives to lend. e e Fisher equation: i = r + π OR r = i – π Where i = nominal interest rate r = real interest rate e π = expected rate of inflation (Understand questions 1, 5, 11) Chapter 4 1. Would a dollar tomorrow be worth more to you today when the interest rate is 20% or when it is 10%? The present value moves opposite to the interest rate, therefore, today’s value will be lower if the interest rate is 20%. 5. A financial adviser has just given you the following advice: “longterm bonds are a great investment because their interest rate is over 20%”. Is the financial adviser necessarily right? It depends on what you think will happen to interest rates in the future. If you expect interest rates to rise, then no, since the price of the bond would fall in the future. If you think interest rates will fall, then yes, since the price of the bond would rise in the future. 11. If interest rates decline, which would you rather be holding, longterm bonds or shortterm bonds? Why? Which type of bond has a greater interest rate risk? If interest rates fall, I would prefer to be holding longterm bonds now. Bond prices and interest rates move in opposite directions and the longer the time to maturity the larger the price change in response to the interest rate change. Therefore, I expect to see a larger capital gain with the longterm bond. Longterm bonds have the greater interest rate risk. Chapter 5 Asset: a piece of property that is a store of value. Determinants of Asset Demand Wealth: total resources owned by the individual, including all assets. Expected Returns: (the return expected over the next period) on one asset relative to alternative assets. Risk: the degree of uncertainty associated with the return on one asset relative to alternative assets. Liquidity: the ease and speed with which an asset can be turned into cash relative to alternative assets. Theory of Portfolio Choice Holding all other factors constant – 1. The quantity demanded of an asset is positively related to wealth. 2. The quantity demanded of an asset is positively related to its expected return relative to alternative assets. 3. The quantity demanded of an asset is negatively related to the risk of its returns relative to alternative assets. 4. The quantity demanded of an asset is positively related to its liquidity relative to alternative assets. Bond Market Demand Curve: relationship between the quantities demanded of bonds and the price of bonds when all other variables are held constant. Remember that the bond demanders have excess funds. They are the lenders in our model. Supply Curve: relationship between the quantity supplied and the price when all other economic variables are held constant. Remember that the bond suppliers are those that need to borrow. Equilibrium: Market Equilibrium occurs when quantity demanded equals quantity supplied at the point where the demand curve and the supply curve intersect (cross each other). This point gives the equilibrium price and the equilibrium interest rate since each price is associated with a specific yield. The market will always move toward equilibrium. Excess Demand: If there is excess demand (quantity demanded is greater than quantity supplied) price will rise (interest rates will fall). Excess Supply: If there is excess supply (quantity supplied is greater than quantity demanded) price will fall (interest rates will rise). Change in Q Demanded: If the price of bonds changes, move along the existing bond demand curve. This is a change in quantity demanded. Change in Q Supplied: If the price of bonds changes, quantity supplied of bonds changes, move along the existing supply curve. Shift demand curve for bonds: Wealth: increases shift bond demand right Expected returns: (relative to other assets) Other assets expect an increase in returns – bond demand decreases (shift left) Expected interest rates to increase – bond demand decreases (shift left) Expected inflation increases – bond demand decreases (shift left) Risk: Risk of bonds increases relative to other assets – bond demand decreases (shift left) Liquidity: Liquidity of bonds increases relative to other assets – bond demand increases (shift right) Shift the supply curve for bonds: Exp. profitability of investments Business cycle expansion – bond supply increases Business cycle recession – bond supply decreases Expected inflation real cost of borrowing falls, bond supply increases Government activities/budget needs Budget deficit – bond supply increases Budget surplus – bond supply decreases Equilibrium interest rates: Fisher effect: change in the interest rate due to expected inflation Expected inflation increases Bond demand decreases Bond supply increases Bond price falls – interest rates increase Business cycle expansion Bond supply increases Bond demand increases (because wealth increases) Bond supply moves more than bond demand thus bond prices fall and interest rates increase Liquidity Preference Framework: Determining equilibrium interest rates using the market for money. The interest rate determined using the market for money is the same that would be determined using the bond market. Shifts in Supply of Money Fed. Res. Changes: Money Supply shifts when the central bank (the U.S. Federal Reserve) changes it. An increase in the money supply shifts the curve to the right. Shifts in the Demand for Money Income changes/Income Effect – more transactions mean that demand for money increases (shift right) Price Level changes/Pricelevel Effect – higher prices means higher demand for money to make transactions (shift right) Liquidity effect moves the interest rate opposite to the income effect, price level effect, and the expectations effect in the market for money (Understand questions 1, 2, 3, 4, 8, 9, 10, 12, 14, 15, 21) 1. Explain why you would be more or less willing to buy a share of Microsoft stock in the following situations: a. Your wealth fallsLESS b. You expect the stock to appreciate in value MORE c. The bond market becomes more liquid LESS d. You expect gold to appreciate in value LESS e. Prices in the bond market become more volatile MORE 2. Explain why you would be more or less willing to buy a house under the following circumstances: a. You just inherited $100,000 MORE b. Real estate commissions fall from 6% of the sales price to 5% of the sales price MORE c. You expect Microsoft stock to double in value next year LESS d. Prices in the stock market become more volatile MORE e. You expect housing prices to fall LESS 3. Explain why you would be more or less willing to buy gold under the following circumstances: a. Gold again becomes acceptable as a medium of exchange MORE b. Prices in the gold market become more volatile LESS c. You expect inflation to rise, and gold prices tend to move with the aggregate price level MORE d. You expect interest rates to rise MORE 4. Explain why you would be more or less willing to buy longterm AT&T bonds under the following circumstances: a. Trading in these bonds increases, making them easier to sell MORE b. You expect a bear market in stocks (stock prices are expected to decline) MORE c. Brokerage commissions on stocks fall LESS d. You expect interest rates to rise LESS e. Brokerage commissions on bonds fall MORE 8. What effect will a sudden increase in the volatility of gold prices have on interest rates? Gold is riskier, demand for bonds increases, the equilibrium bond price increases and therefore, I expect interest rates to fall. 9. How might a sudden increase in people’s expectations of future real estate prices affect interest rates? I want to purchase the real estate today before the price goes up. My demand for bonds decreases, the equilibrium bond price decreases and therefore, I expect interest rates to rise. 10. Explain what effect a large federal deficit should have on interest rates. If the federal budget deficit increases, the U.S. Treasury will need to borrow more funds by selling bonds. The bond supply increases, the equilibrium bond price decreases and therefore, I expect interest rates to increase. 12. Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain your answer. I expect a greater return in stock. My demand for bonds decreases, the bond price decreases and, therefore, I expect interest rates to increase. 14. Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices. I want to purchase stock today before the price goes up. My demand for bonds decreases, the bond price decreases, and therefore, I expect interest rates to increase. 15. Predict what will happen to interest rates if prices in the bond market become more volatile. Bonds are riskier. My demand for bonds decreases, the bond price decreases, and therefore, I expect interest rates to increase. 21. An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework? In the bond market, the supply of bonds increases, the bond price decreases, and therefore, I expect the interest rate to increase. In the liquidity preference framework, the supply of money decreases, and the equilibrium interest rate increases. NOTE: Visit your class lecture notes for graphical examples P.S. If you do not have the (detailed) notes, I have posted week 4 notes on my study soup, so do check them for all the graphical examples discussed in class for chapter 5. I take awesome notes and my graphs are drawn from her diagrams in class. GOOD LUCK!!!
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