Topic 5: Portfolio Theory Flashcards
Show the steps to get Baumol’s rule.
π = r(Wt - Mt) - ctN
Where underlined variables are averages.
As N = Wt/Qt
Qt = 2Mt (Volume of each bank transaction).
N = Wt/Mt
So π = r(Wt - Mt) - ct(Mt/Wt)
Maximise for Mt to get solution.
State Barmol’s Square Rule
Where Mt = Average transactions demand for money in period t.
Wt = Average wealth for the period t.
ct = Brokerage fee to switch between money and bonds. (In dollars.)
rt = Interest rate on bonds in period t.
Show the MC and MB of holding money diagram, and use it to explain the effects of a decrease in interest rates on transaction demand.
Show the utility curve analysis of transactions demand for a decrease in interest rates.
Show the utility curve analysis model for precautionary demand.
Show a risk lovers utility curve for their portfolio.
Show how speculative demand can be graphed:
Show the graph for speculative and precautionary demand for money.
Graph the result of combining the all three motivations for money.
