Test Two Flashcards
A theory assuming that people’s expectations are the best possible forecast based on all public information, NOT ALWAYS 100% ACCURATE.
Rational expectations
if a bond is held to maturity
The rate of return is the yield to maturity
if a bond is sold before maturity
It’s rate of return is the current yield plus the percentage capital gain or loss
what happens to a bond’s price if the yield to maturity rises sharply?
The price falls
Are short-term or long-term bonds more volatile
Long-term
what risk is avoided if a bond’s time to maturity matches its holding period?
Interest-Rate Risk
The rate savers can receive with certainty
risk-free rate
what reduces the present value of future income?
Risk
payment on an asset that compensates the owner for taking risk
risk premium
risk premium _______ with the riskiness of the asset
increases
Asset prices change when?
When expected income or interest rates change
Stock prices change when?
expected income changes
changes in company earnings have what kind of effect on bond prices
little to no effect
Ex ante
Before (expected inflation)
Ex post
After (actual inflation)
what interest rate is adjusted for changes in price level and is a more accurate reflection of the cost of borrowing
Real interest rate
if inflation is higher than expected how are the ex post and ex ante real interest rates affected?
the ex post real interest rate is lower than the ex ante rate
pricing inflation cased negative ex post returns on mortgages issued by savings and loan associations resulted in what
the savings and loan crisis
what makes borrowing and lending risky
uncertainty about inflation
what type of bonds promise a fixed real interest rate: the nominal rate is adjusted for inflation over the life of the bond
inflation-indexed bonds
how are inflation-indexed bonds effected by inflation increases
The nominal interest rate on the bond is increased by and equal percentage
what are the fundamental forces determining interest rates
- Time preference
- marginal product of capital
- income
- inflation expectations
- monetary policy
- federal budget deficits (surpluses)
What 2 motives determine the shape of indifference curves
Current consumption & deferred current consumption
higher income shifts the budget constraint out leading to
higher savings
what is the reward to saving?
Interest rates. Productivity of capital is the source of that reward
how does a fall in marginal product of capital affect the demand curve for loanable funds
The demand curve shifts to the left
income fall can have a ____________ effect on interest rates
positive the supply curve of loanable funds shifts to the left
during a recession which curve has the greater shift
demand curve
a rapid increase in asset prices not justified by a change in interest rate or expected asset income
asset-price bubble
are bonds or stock prices more volatile
Stocks, they provide income farther into the future than bonds.
the price of a stock divided by earnings over the recent past
price-earnings ratio
what increases p/e ratio?
low interest rates and high expected earnings in the future
what happens to interest rates during periods which people expect inflation to increase
interest rates rise
what happens to interest rates when people expect inflation to decline
interest rates typically fall
_____ require that the exchange shuts down temporarily if prices drop by a certain percentage
Circuit breakers (established following 1987 crash)
circuit breakers stop what type of selling
panic selling
to stimulate the economy the fed implements measures that:
- encourage banks to expand loans
- thereby boosting the money supply moving the supply curve of loanable funds rightward
- thereby reducing interest rates
to restrain economic activities the fed implements actions that:
- force banks to reduce their lending
- thereby curtailing the money supply, moving the supply curve of loanable funds leftward
- thus increasing interest rates
does the fed res. have a considerably more direct influence on short-term interest rate or long-term rates
Short-term
What effect does a federal budget deficit have on the demand curve
A right ward shift therefore a increase in interest rates
What proposition suggests that people will offset fiscal deficits with greater savings to pay future taxes, especially if the increase in gov spending is expected to be permanent
The Ricardian Equivalance
The total resouces owned by individuals including all assets
Wealth
the degree of uncertainty associated with the return on one asset relative to alternative assets
Risk
the ease and speed with which an asset can be turned into cash relative to alternative assets
Liquidity
wealth and quantity demanded have what kind of relationships
Positive
expected return and quantity demanded have what kind of relationship
positive
quantity demanded and risk are _____ related
negatively related
quantity demanded and liquidity
positively related
sources of supply:
- personal saving
- business saving
- government budge surplus
- foreign lending in the US
Sources of Demand
- household credit purchases
- Business investment spending
- government budget deficit
- foreign borrowing in the us
what occurs when the amount demanded equals the amount supplied at a given price
market equilibrium
supply curve shifters
- expected profitability of investment opportunities
- expected inflation
- government budget
a higher level of income causes the demand for money at each interest rate to increase and the demand curve to shift to the right
Income Effect
a rise in the price level causes the demand for money at each interest rate to increase and the demand curve to shift to the right
Price-Level Effect
an increase in the money supply will lower interest rates refers to what effect?
Liquidity
what are the goals of monetary policy
- keep stable prices (low/in volatile inflation)
- maximize employment (increase output
