money market Flashcards
what are the two financial assets that the average person has ?
money - safe asset - currency and checkable deposits
bonds - risky assets - interest bearing
the amount you chose to hold depends on IR and Levels of transaction
what are the motives for holding money ?
transitionary - function of Y - + relation
precautionary - function of Y - + relation
speculative - function of Y - - relation
what is the equation for money demand ? and what affects it ?
Md = £Y . L ( i )
income level x function of IR
Md rises as Y rises
Md falls as IR rises
how much money does the central bank supply ?
the exact amount where Ms = Md
this is equilibrium in the money market
how do you draw the money market on a graph ?
the money supply line is a vertical straight line whilst the moony demand curve is a convex line. the x axis is Q and the Y axis is IR . the pink where they meet is labeled as i and q
also known as IR equilibrium
what does an increase in £Y ( income level ) do to the money market diagram ?
it will lead to an outward shift of the Md curve and increase in i.
what changes the money supply ?
- QMd changes
- monetary policy adjustments
on the graph; an increase in the Ms would lead to a decrease in the IR but in reality ……. ???
it is the other way around.
describe the money market when its in excess demand ?
Md has increased but IR has not risen accordingly as Ms hasnt been changed yet to adjust to the new Md
so IR are too low ( too risky )
consumers sell bonds to hold safer assets
Qbonds rises - Pbonds falls - inverse relationship IR rises
until Md and and Ms is back at equilibrium
describe the money market when its in excess supply ?
Ms has shifted out but i hasn’t fallen yet
IR is too high ( worth increases )
Dbonds increases - Pbonds increases - IR falls
back to equilibrium
what relationship to bonds and interest rates have ?
an inverse realtionship
what is a bond and how does it work ?
a certificate from a financial instiution that you have loaned money too
face value - upfront cost
IR / Coupon Rate - how much more you get payed back at the end of its life span = Cp / Pb
Coupon payment per year - amount you get payed every year
what happens if the price of the bond…
a. increases
b. decreases
a. Pb rises i = 10/110 = 0.09 = 9% IR has fallen
b. Pb falls i = 10/90 = 0.11 = 11% IR has risen - more desirable as you get more back at the end
they have an inverse relationship
best
what is scenario 2 of the supply of money ?
the supply of money when it includes
. currency, supplied by the central bank
. deposit accounts, supplied by banks ( non interest )
what assets and liabilities do central banks and commercial banks hold ?
central banks
assets - bonds
liabilities - currency, reserves
commercial banks
assets - loans, reserves
liabilities - deposits
why do banks keep reserves ?
- need by depositors to withdraw cash
- banks may owe each other at the day end
- legal requirement ( reserve requirement as a % of deposits ) in us - 0 - 10%
they make banks safer, especially if there should be another crisis.
what is the demand for money in scenario 2 ?
supply and demand for overall money ( including central bank money )
made up of D for deposit accounts and
CU for currency
what does Md = in scenario 2 ?
Md = Dd + CUd
CUd as a fixed percentage = C . Md
c - % of currency we keep
and (1 - c) .Md what ever is left goes in the deposit account
and we must introduce CB money - demand by banks for reserves
Rd = theta.Dd
= theta(1-C).Md
there for D for CB money ( currency and reserves )
Hd = Cud + Rd
= C.Md + theta.(1-C).Md
= Md . ( C + theta.(1-C))
what does Hd look like when its considered as a proportion of overall demand for money ?
Hd = [ C + theta . (1-C) ] . £Y . L( i )
and Hs is =
what is the money multiplier ?
Ms = Md = (1 / [ C + theta . (1-C) ] ) x Hd
in equilibrium H = Hd therefore
Ms = ( 1 / [ C + theta . (1-C) ] ) x H
H - supply of CB money ( monetary base )
if there is a change in the monetary base , because the CB has maybe performed monetary policy, the multiplies tells us how this effects the supply of money in the economy, as it effects commercial reserves.
whats the liquidity trap ?
an extreme scenario
where there is extremely low IR environment
- CB cannot affect IR through normal monetary policy
- people hold money transactions as usual
- indifference between bonds and deposits
- bond prices are maxed ( can only fall ) so people panic sell
- monetary policy becomes powerless
- need to use QE ?
when the increase in the money supply or liquidity doesn’t effect IR
what is the euro central bank ?
- controls euro monetary policy
- they decide the refi rate ( re finance rate ) the rate at which country borrow from the ECB when they are short of funds.
- increases or decreases in the refi rate can influence the IR that banks set for a number of things
what is securitisation ?
important financial development if 1990s - 200s
traditionally banks or any intermediaries who loaned out mortgages or loans kept them on their own balance sheet.
local banks who only loaned out local loans and mortgages are much more exposed to local economic shocks.
having more diverse loans helps them avoid bankruptcy - called securitisation
it is the creation of securities based on bundles of assets ( e.g. a bundle of loans and morgages)
what is an MBS ?
mortgage based security
