AP EXAM: Unit 4 Flashcards
What’s the most liquid form of money?
Cash
What are bonds?
Interest-bearing debt contracts issued by governments or corporations
Why is interest rate important in bonds?
No rational investor would be willing to pay without getting a sufficient rate of return, because there’s no benefit.
Interest on Investment (Formula)
Investor’s return/Purchase price x 100
Role of interest rate in investment and demand for money
Demand for money is inversely related to interest rate in the economy
How is nominal interest rate set?
Based on desired rate of return and expected rate of inflation
Role of expected inflation in the economy
Higher expected inflation will lead banks to raise the inflation premium and increase NIR
Commodity money
Value comes from the commodity of which it is made
Fiat money
No intrinsic value
Three functions of money
Medium of exchange, store of value, unit of account
Medium of exchange
Money is accepted as a means for purchasing goods, services, or other assets
Store of value
Assets can transfer purchasing power from present to future
Unit of account
Used to express the value of something
M0
Monetary base (currency in circulation, reserves held at bank)
M1
Monetary base + Demand Deposits
M2
M1 + Savings, MM Mutual Funds, broadest measure of money supply
Reserve requirement ratio
Required reserves/Total deposits
Money multiplier
1/RRR
Relationship of money multipler and money supply/monetary base
Money multiplier is ratio of money supply to monetary base
Other ways multiplier can be calculated
M2/M0 (Ratio of M2 over M0)
Asset demand for money
Inversely related to the interest rate
Transaction demand for money
Inversely related to the interest rate
What causes changes in the money demand curve?
Change in national income and consumption
Factors that shift the supply of money
Monetary policy