5a Flashcards
4 factors that affect demand for an asset
- wealth
- expected return
- risk
- liquidity
what is wealth
the total resources owned by the individual, including all assets.
what is expected return
the return expected over the next period on one asset relative to alternative assets.
what is risk
the degree of uncertainty associated with the return on one asset relative to
alternative assets.
what is liquidity
the ease and speed with which an asset can be turned into cash relative to
alternative assets.
what is the theory of asset demand (theory of portfolio choice)?
It explains how the quantity demanded of an asset is determined based on wealth, expected return, risk, and liquidity.
What factors positively affect the demand for an asset?
Wealth – More wealth increases asset demand.
Expected Return (relative to other assets) – Higher returns make an asset more attractive.
Liquidity (relative to alternatives) – More liquid assets are preferred.
What factor negatively affects the demand for an asset?
Risk of its returns (relative to alternative assets) – Higher risk lowers demand.
What does bond market analysis focus on?
The supply and demand for bonds.
What is the relationship between bond prices and interest rates?
They have a negative relationship—when bond prices decrease, interest rates increase, and vice versa.
How does the quantity demanded of bonds change with bond prices?
At lower bond prices (higher interest rates), the quantity demanded of bonds increases (all else held constant).
How does the quantity supplied of bonds change with bond prices?
At lower bond prices (higher interest rates), the quantity supplied of bonds decreases (all else held constant).
What is bond market equilibrium?
It occurs when the demand for bonds equals the supply of bonds at a given price.
What happens when Bd = Bs in the bond market?
It indicates the equilibrium (market-clearing) price and interest rate.
What happens when Bd > Bs in the bond market?
It indicates excess demand for bonds, causing the bond price to rise and the interest rate to fall.
What happens when Bd < Bs in the bond market?
It indicates excess supply of bonds, causing the bond price to fall and the interest rate to rise.
How will equilibrium interest rates change when factors affecting demand for bonds change?
Changes in factors affecting demand will shift the demand curve, changing the equilibrium price and interest rate.
How will equilibrium interest rates change when factors affecting supply of bonds change?
Changes in factors affecting supply will shift the supply curve, affecting the equilibrium price and interest rate.
What is the difference between a movement along a curve and a shift in a curve?
A movement along a curve occurs when the quantity of bonds demanded/supplied changes due to a change in the price (P).
A shift in a curve happens when the quantity of bonds demanded/supplied changes at every price due to a change in factors affecting demand or supply.
What causes a movement along a curve in the bond market?
A movement along a curve happens when the price of bonds changes, which causes the quantity of bonds demanded/supplied to change.
What causes a shift in a curve in the bond market?
A shift in the curve happens when factors other than the price (such as changes in income, expectations, risk, or fiscal policy) affect the demand or supply of bonds at all prices.
How does wealth affect the demand for bonds?
An expansion in wealth or an increase in household savings shifts the demand curve for bonds to the right.
How do expected returns affect the demand for bonds?
Higher expected interest rates in the future decrease the expected return for long-term bonds, shifting the demand curve to the left.
Higher expected return on alternative assets reduces the demand for bonds, shifting the demand curve to the left.
Higher expected inflation reduces the expected return for bonds, shifting the demand curve to the left.
How does risk affect the demand for bonds?
Increased riskiness of bonds shifts the demand curve to the left.
Increased riskiness of alternative assets shifts the demand curve to the right.
How does liquidity affect the demand for bonds?
Increased liquidity of bonds shifts the demand curve to the right.
Increased liquidity of alternative assets shifts the demand curve to the left.
How does expected profitability of investment opportunities affect the supply of bonds?
An expansion in the business cycle increases the expected profitability of investment opportunities, shifting the supply curve to the right.
How does expected inflation affect the supply of bonds?
Higher expected inflation lowers the real cost of borrowing, leading to an increase in the supply of bonds, shifting the supply curve to the right.
How does the government budget affect the supply of bonds?
Higher budget deficits increase the supply of bonds, shifting the supply curve to the right.
3 factors that shift the supply of bonds
expected profitability - expansion so more bond supply
expected inflation
government budget
