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Market analysis- 220 > chapter 11: the behavior of interest rates > Flashcards

chapter 11: the behavior of interest rates Flashcards

1
Q

asset

A

a piece of property that is a store of value

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2
Q

what must one consider when choosing whether to hold an asset or not?

A

wealth

expected return

risk

liquidity

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3
Q

wealth

A

the total resources owned by the individual, including all assets

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4
Q

expected return

A

the return expected over the next period

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5
Q

risk

A

the degree of uncertainty associated with the return

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6
Q

liquidity

A

the ease and speed with which an asset can be turned into cash

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7
Q

holding everything else constant, how does an increase in wealth affect the quantity demanded of an asset?

A

increases quantity demanded of an asset

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8
Q

how does an increase in an asset’s expected return relative to that of an alternative asset affect quantity demanded of former?

A

raises the quantity demanded of the asset

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9
Q

since more people are risk averse, how does the rise in risk of an asset affect quantity demanded of the asset

A

Qd will fall

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10
Q

how does liquify affect quantity demanded of an asset?

A

he more liquid an asset is relative to alternative assets, holding everything else unchanged, the more desirable it is, and the greater will be the quantity demanded

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11
Q

theory of asset demand

A
  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.
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12
Q

a bond demand curve

A

which shows the relationship between the quantity demanded and the price

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13
Q

ceteris paribus

A

latin for other things being equal”

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14
Q

formula for bond expected return and interest

A

i = RET = (F - P) / P

I = interest rate = yield to maturity

RET = expected return

F = face value of the discount bond

P = initial purchase price of the discount bond

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15
Q

will higher interest rates increase or decrease the Qd of bonds? why?

A

Qd will increase the higher the interest rates

prices will be cheaper and cheaper

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16
Q

bond supply curve

A

shows the relation- ship between the quantity supplied and the price of bond

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17
Q

how do interest rates of a bond affect supply?

A

the lower the rate, the higher the price, the more the Qs

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18
Q

bond market equilibrium

A

when the quantity of bonds demanded equals the quantity of bonds supplied

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19
Q

excess supply of bonds

A

more bonds supplied than bonds demanded

will drive price down eventually to equilibrium

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20
Q

excess demand of bonds

A

more bonds demanded than bonds supplied

will drive price up eventually to equilibrium

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21
Q

The asset market approach for understanding behaviour in financial markets

A

emphasizes stocks of assets rather than flows in determining asset prices

the dominant methodology used by economists because correctly conducting analyses in terms of flows is very tricky, especially when we encounter inflation

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22
Q

factors that cause the demand curve for bonds to shift

A
  1. Wealth
  2. Expected returns on bonds relative to alternative assets
  3. Risk of bonds relative to alternative assets
  4. Liquidity of bonds relative to alternative assets
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23
Q

in a business cycle expansion with growing wealth, what happens to overall demand of bonds?

basically when economy is booming

A

the demand for bonds rises and the demand curve for bonds shifts to the righ

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24
Q

in a recession with decreasing wealth, what happens to overall demand of bonds?

basically when economy is trash

A

the demand for bonds falls, and the demand curve shifts to the left

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25
Q

how does an expectation that interest rates will rise affect the demand curve for bonds? why?

A

Higher expected interest rates in the future lower the expected return for long-term bonds

decrease the demand

shift the demand curve to the left

higher interest rates = decrease in price

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26
Q

how does an expectation that interest rates will fall affect the demand curve for bonds? why?

A

lower expected interest rates in the future increase the expected return for long-term bonds

increase the demand

shift the demand curve to the right

lower interest rates = increase in price

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27
Q

if people thought that stocks will bring more return than bonds in the future, how will it affect the bond demand curve? why?

A

the expected return on bonds today relative to stocks would fall

lowering the demand for bonds and shifting the demand curve to the left.

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28
Q

if people thought that stocks will bring less return than bonds in the future, how will it affect the bond demand curve? why?

A

the expected return on bonds today relative to stocks would rise

increasing the demand for bonds and shifting the demand curve to the right.

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29
Q

what does an increase in expected rate of inflation affect demand for bond?

A

lowers the expected return for bonds, causing their demand to decline and the demand curve to shift to the left

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30
Q

what does an decrease in expected rate of inflation affect demand for bond?

A

increases the expected return for bonds, causing their demand to increase and the demand curve to shift to the right

31
Q

how does an increase in the risk of bonds affect the demand for bonds?

A

causes the demand for bonds to fall and the demand curve to shift to the left

32
Q

how does a decrease in the risk of bonds affect the demand for bonds?

A

causes the demand for bonds to rise and the demand curve to shift to the right

33
Q

how does an increase in the risk of other assets such as stocks affect the demand for bonds?

A

causes the demand for bonds to rise and the demand curve to shift to the right

34
Q

how does a decrease in the risk of other assets such as stocks affect the demand for bonds?

A

causes the demand for bonds to decrease and the demand curve to shift to the left

35
Q

how does an increase in liquidity of bonds affect the demand for bonds? why?

A

Increased liquidity of bonds results in an increased demand for bonds

the demand curve shifts to the right

it means more people are in the market and you can sell your bonds faster

36
Q

how does a decrease in liquidity bonds affect the demand for bonds? why?

A

decreased liquidity of bonds results in an decrease demand for bonds

the demand curve shifts to the left

it means less people are in the market and you have more trouble selling your bond

37
Q

how does an increase in liquidity of other assets affect the demand for bonds?

A

lowers the demand for bonds and shifts the demand curve to the left

38
Q

how does a decrease in liquidity of other assets affect the demand for bonds?

A

increases the demand for bonds and shifts the demand curve to the right

39
Q

Certain factors can cause the supply curve for bonds to shif

A
  1. Expected profitability of investment opportunities
  2. Expected inflation
  3. Government activities
40
Q

how does a business cycle expansion (booming economy) affect the bond supply? why?

A

the supply of bonds increases

the supply curve shifts to the right

companies expect to make more money but they still need capital, so they can borrow more, hence selling more bonds

41
Q

how does a recessions affect the bond supply? why?

A

the supply of bonds decrease

the supply curve shifts to the left

companies don’t expect to make more money so they don’t need capital

they are not willing to borrow, sense are not selling as many bonds

42
Q

how does an increase in expected inflation affect supply? why?

A

causes the supply of bonds to increase

the supply curve to shift to the right

when expected inflation increases, the real cost of borrowing falls

corporations and government need to borrow more

43
Q

how does an increase in expected deflation affect supply?

A

causes the supply of bonds to decrease

the supply curve to shift to the increase

44
Q

how do higher government deficits affect the supply of bonds? why?

A

increase the supply of bonds

shift the supply curve to the right

he government sells more bonds to get money to finance these deficits

45
Q

how do higher government surpluses affect the supply of bonds?

A

decrease the supply of bonds and shift the supply curve to the left

46
Q

how does expected a rise in expected inflation affect interests? why?

A

interest rates will rise

there is more supply of bonds and less demand

supply of bonds shifts to right and demand shifts to right

new equilibrium price is lower

a lower price = higher interest rates

47
Q

how will a decrease in inflation affect interests?

A

interest rates will decrease as well

48
Q

how will a booming economy impact interest rates? why?

A

interest can either rise or fall, it will depend on which of the supply and demand curve shifts the most

both of the curves shift to the right in this case

49
Q

are low interests always a good thing? give an example with asian country

A

no it is not always a good thing

it may seem like its cheaper to borrow as a corporation, but it usually means that you economy is in trouble

Japan got negative interest rates for the first time and they were low-key screwed

50
Q

how does a decrease in wealth (as a consumer) affect bond interest rates?

A

interest rates rise

since the demand for bonds decrease, the curve shifts to the left

the equilibrium will be lower which means bond prices are lower which means interests rate

51
Q

liquidity preference (John Maynard Keynes)

A

alternative model for determining the equilibrium interest rate

determines the equilibrium interest rate in terms of the supply of and demand for money

52
Q

The starting point of Keynes’s analysis

A

there are two main categories of assets that people use to store their wealth: money and bonds

total wealth in the economy must equal the total quantity of bonds plus money in the economy

equals the quantity of bonds supplied Bs plus the quantity of money supplied Ms

The quantity of bonds Bd and money Md that people want to hold and thus demand must also equal the total amount of wealth, because people cannot purchase more assets than their available resources allow

53
Q

liquidity preference (John Maynard Keynes’) formula

A

the quantity of bonds and money supplied must equal the quantity of bonds and money demanded

Bs + Ms = Bd + Md

Bs - Bd = Md - Ms

54
Q

Keynes’ definition of money includes what?

A

currency (which earns no interest)

chequing account deposits (which in his time typically earned little or no interest),

he assumed that money has a zero rate of return

55
Q

the demand for money is positively or negatively related to interest rates? why?

A

negatively related

the opportunity cost of not holding a bond in favor of money

56
Q

how does a rise in interest rate affect the demand for money?

A

the opportunity cost of holding money increases

money becomes less desirable and the quantity of money demanded must fall

57
Q

how does a decrease in interest rate affect the demand for money?

A

the opportunity cost of holding money decrease

money becomes more desirable and the quantity of money demanded must rise

58
Q

explain how a market will a surplus of money supplied

A

The excess supply of money means that people are holding more money than they desire

they will try to get rid of their excess money balances by trying to buy bonds

they will bid up the price of bonds, and as the bond price rises, the interest rate will fall toward the equilibrium interest rate

59
Q

explain how a market will a deficit of money supplied

basically more money demanded than money supplied

A

excess demand for money because people want to hold more money than they currently have

To try to obtain more money, they will sell their only other asset (bonds) and the price will fall

As the price of bonds falls, the interest rate will rise toward the equilibrium rate

60
Q

In Keynes’ liquidity preference analysis, which two factors cause the demand curve for money to shift?

A

income and the price level

61
Q

how does a higher income (income effect) affect the demand for money? why?

A

causes the demand for money at each interest rate to increase and the demand curve to shift to the right

people will want to hold more money as a store of value whenever there is an economic boom and overall income increases

as the economy expands and income rises, people will want to carry out more transactions using money, with the result that they will also want to hold more money

62
Q

what does a rise in prices do to the demand for money? why?

A

causes the demand for money at each interest rate to increase and the demand curve to shift to the right

people want to buy what they used to buy now at higher prices

63
Q

how does a rise in income in a booming economy affect interest rates? why?

Keynes’ logic

A

interest rates will rise

demand for money is shifted to the right which means that new equilibrium is now higher than previous equilibrium

people do not want bonds, which means they well sell them, which lowers their price, which make interests rise

64
Q

how does a decrease in income in a recession affect interest rates? why?

Keynes’ logic

A

interest rates will decrease

demand for money is shifted to the left which means that new equilibrium is now lower than previous equilibrium

people want bonds instead of money, which means they well buy them, which increases their price, which make interests decrease

65
Q

how does a rise in prices in a booming economy affect interest rates? why?

Keynes’ logic

A

interest rates will rise

people have increased their demand for money

they will sell bonds to get that money which will decrease their price

66
Q

how does an increase in supply of money affect interest rates? is this ways true?

A

interest rates will decline

the new equilibrium will be lower than the `previous one

not this is not always true

67
Q

the income effect of an increased supply of money on interest rates

why is it like this?

A

the income effect of an increase in the money supply is a rise in interest rates

it is response to the higher level of income that people now have

higher income means higher demand for money which means less bonds which means higher interest rates

68
Q

the price level effect of an increased supply of money on interest rates

why is it like this?

A

a rise in interest rates in response to the rise in the price level

higher prices means higher demand for money which means less bonds which means higher interest rates

69
Q

expected inflation effect of an increased supply of money on interest rates

why is it like this?

A

is a rise in interest rates in response to the rise in the expected inflation rate

in response to price being higher as well

higher prices means higher demand for money which means less bonds which means higher interest rates

70
Q

difference between price level effect and expected inflation effect

A

the price-level effect remains even after prices have stopped rising, whereas the expected-inflation effect disappears

the expected-inflation effect will persist only as long as the price level continues to rise

However, when the price level stops rising next year, inflation and the expected inflation rate will return to zero. Any rise in interest rates as a result of the earlier rise in expected inflation will then be reversed

71
Q

so what is the verdict with the increase of supply of money? how does it affect interest rates?

A

he rising money supply leads to an immediate decline in the equilibrium interest rate

The income and price-level effects take time to work because it takes time for the increasing money supply to raise the price level and income, which in turn raise interest rates

The expected-inflation effect, which also raises interest rates, can be slow or fast, depending on whether people adjust their expec- tations of inflation slowly or quickly when the money growth rate is increased.

72
Q

how does a bigger liquidity effect affect the interest rate after supplying more money?

A

the bigger the liquidity effect, the less chances that the interest rate will return to the original state after the income, price level, and expected inflation effects take place

73
Q

what happens if the expected inflation effect takes over after pumping money?

A

interest immediately rise

government takes a L

74
Q

how does a liquidity effect smaller than the income, price level, and expected inflation effects affect the interest rate after supplying more money?

A

at first interest will lower, but then after it will be even higher than the original level

Market analysis- 220 (41 decks)

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