BONDS

Question 1

Money definition

Answer 1

Assets that are widely used + accepted as payment

Question 2

M1 monetary aggregate

Answer 2

Currency + travellers checks, transaction accounts on which checks may be drawn

(closest to theoretical definition of money)

Question 3

M2 monetary aggregate

Answer 3

M1 + less ‘money-like’ assets like saving deposits and money market mutual funds etc.

Question 4

Functions of money

Answer 4

• Medium of exchange (device for making transactions)
• Unit of account (basic unit for measuring value)
• Store of value (holds wealth)

Remember - MUS

Question 5

Make portfolio decision based on

Answer 5

Liquidity (want higher)
Expected return (want higher)
Risk (want lower - so bears risk premium)
Time to maturity (want lower - so bear risk (?) premium )

Remember LERT

Question 6

Rate of Return

Answer 6

Rate of increase in the value of asset per unit of time e.g. interest rate, RoR of share see below

Question 7

Rate of Return of a share

Answer 7

Dividend yield + % increase in stock price. E.g. Buy a share for £60, sell for £80, earn £10 in dividends. Increase in stock price is £20, so total money gained from owning stock is £30. This is 50% of cost of it so RoR is 50% (i.e. get 50% extra of original value from having it in portfolio).

Question 8

Risk

Answer 8

Degree of uncertainty in assets return.

Question 9

Risk premium

Answer 9

Amount by which expected return on a risky asset exceeds return on an otherwise comparable safe asset.

(Helps decide whether worth it to hold or not)

Question 10

Liquidity

Answer 10

Ease + quickness with which an asset can be traded e.g. cars / houses not v liquid bc large transactions costs & time to trade.

Question 11

Time to maturity

Answer 11

Time until financial security matures + investor is paid the principal. Also holds risk premium, amount by which expected return on a long term bond exceeds that of an otherwise comparable short term bond.

Question 12

Coupon bond

Answer 12

Bond where get a fixed interest payment every year for holding, and face value (is this the principal or current value??) repaid at maturity date.

Question 13

Consol bond / perpetuity

Answer 13

No maturity date so no repayment of principal just fixed coupon payments forever.

Question 14

Discount bond

Answer 14

Bought at a price below its face value, face value repaid at maturity date.

Question 15

Yield to maturity (think mainly used for discount bonds)

Answer 15

Interest rate on a discount bond that equates the present value of cash flow payments received from a bond with its value today.

Pb =F/(1+i)^n so basically this I rate means that over n number of years at this I rate you get the real face value back??

Question 16

Money supply

Answer 16

Amount of money available in economy

M^s=M ̅(bar underneath)

Question 17

Money demand

Answer 17

Essentially the quantity of monetary assets people choose to hold in portfolios.

Md = Sum of all individual money holding demands (aggregate money demand).

Question 18

2 asset model

Answer 18

Md + Bd = W (in whatever monetary units e.g. $ or £)

So though money demand ^ with ^ in real income Y, will be less than proportional bc bond demand will also increase, so money demand rises less than 1% to a 1% increase in real income.

Question 19

QE

Answer 19

To increase Ms - CB uses newly printed money to buy financial assets from the public > more money in circulation, less bonds.
To decrease Ms - CB sells financial assets to the public, removing money from circulation.

Question 20

Money holding decisions depend on

Answer 20

How much you value liquidity against the low return on money

Question 21

Nominal money demand formula

Answer 21

Md=P×L(Y,i) (so proportional to the price level)

Question 23

Real money demand formula

Answer 23

Md / P = L(Y, i)

Question 23

Factors increasing nominal money demand (thinking about formula)

Answer 23

Bc formula

• Anything that ^ inflation > higher money demand bc money means less so need more of it for same value
• Anything ^ real income
• Anything decreasing nominal interest rate on bonds (which could be a decline in expected inflation so therefore an increase in inf. would only increase money demand if ^P greater than decrease in L bc of ^ in expected inf - double check this)

Question 24

Demand curve for bonds

Answer 24

Downwards sloping

Question 25

Factors increasing demand for bonds

Answer 25

• Increase in wealth
• Increase in expected return of that bond relative to alternative asset
• Decrease in the expected return of alternative assets
• Lower expected future interest rates for bonds with maturities of greater than one year so expected return is higher. (???? I don’t understand)
• Higher liquidity
• Decrease in expected inflation as lowers expected real interest rate on bonds?????
• Decrease in expected inflation as lower price of real assets > lower expected returns on these fall