W3

Question 1

1. The Expected return - Rate of return and (2) examples

Answer 1

Rate of return = an asset’s increase in value per unit of time. 1. Bank account: Rate of return = interest rate. 2. Corporate stock: Rate of return = dividend yield + percent increase in stock price.

Question 2

Investors want assets with the ______ expected return (other things equal).

Answer 2

highest

Question 3

2. RISK (i) What is risk? (ii) people prefer assets with ____ risk (other things equal). (iii) risk premium

Answer 3

(i) Risk is the degree of uncertainty in an asset’s return. (ii) low (iii) amount by which the expected return on a risky asset exceeds the return on an otherwise comparable safe asset

Question 4

3. The Liquidity i. Liquidity and 2 examples ii. Investors prefer _____ assets

Answer 4

i. The ease and quickness with which an asset can be traded Eg: 1. Money is very liquid 2. houses are very illiquid bc long time and large transaction costs to trade them 3. Stocks and bonds are fairly liquid. iii. fairly liquid

Question 5

4. The Time to maturity: i. Time to maturity ii. A _____ time to maturity is usually more desirable (shorter/longer), why?

Answer 5

i. Is the amount of time until a financial security matures and the investor is repaid the principal. ii. shorter. - Because long-term interest rates usually exceed short-term interest rates. - So, a risk premium exists: the compensation to an investor for bearing the risk of holding a long-term bond.

Question 6

5 types of assets and their Return, Risk and Liquidity 1. Money 2. Bonds 3. Stocks 4. Ownership 5. Housing

Answer 6

1. low return, low risk, high liquidity, lowest 0 TTM 2. higher return than money, but have more risk and less liquidity 3. pay dividends and can have capital gains and losses, and are much more risky than money. 4. very risky and not liquid at all, but may pay a very high return. (small business) 5. provides housing services and the potential for capital gains, but is quite illiquid.

Question 7

What is money?

Answer 7

assets that are widely used and accepted as payment.

Question 8

three (3) functions of Money

Answer 8

1. Medium of exchange 2. Unit of account 3. Store of value

Question 9

Medium of exchange (3)

Answer 9

• trade money for g+s - less cost + effort - allows specialisation

Question 10

Unit of account

Answer 10

• $ basic unit for measuring economic value - simplifies comparisons of prices, wages, and incomes

Question 11

Store of value

Answer 11

• $$ is used to hold wealth

Question 12

fiat money

Answer 12

intrinsically useless objects (coins and paper money or cash)

Question 13

Measuring money - monetary aggregates

Answer 13

M1 and M2

Question 14

M1 monetary aggregate

Answer 14

• consists primarily of currency and balances held in checking/transaction accounts. - used in making payments - closest money measure to our theoretical description of money. M1 = Currency + value of demand deposits with banks. (travellers checks, transaction accounts)

Question 15

M2 monetary aggregate

Answer 15

M2 = M1 + less money like assets. also includes: - Savings deposits - small (< $100,000) time deposits - non institutional MMMF balances - money market deposit accounts (MMDAs). - includes certificates of deposit - term deposits - deposits with banks from building societies - credit unions and other authorised deposit taking institutions

Question 16

Broad Money

Answer 16

M3 + deposits into non bank deposit taking financial institutions

Question 17

The money supply

Answer 17

the amount of money available in an economy - determined by the central bank

Question 18

How does the central bank of a country increase the money supply?

Answer 18

• through OMO’s - Use newly printed money to buy financial assets from the public—an open-market purchase - To reduce the money supply, sell financial assets to the public to remove money from circulation—an open-market sale.

Question 19

three (3) key macroeconomic variables that affect money demand

Answer 19

1. Price level 2. Interest rate 3. Real income

Question 20

Macroeconomic determinants of the demand for money (10)

Answer 20

Question 21

money demand function

Answer 21

𝑴^𝒅=𝑷×𝑳(𝒀,𝒊) 𝑴^𝒅=𝑷×𝑳(𝒀,𝒓+𝝅^𝒆 ) Real Money Demand: 𝑴^𝒅/𝑷=𝑳(𝒀,𝒓+𝝅^𝒆 )

Question 22

, nominal money demand is ______ to the price level. i.e., a rise in 𝑌 _____ money demand; a rise in i _____ money demand.

Answer 22

proportional increases decreases

Question 23

The demand for any asset

Answer 23

(e.g., government bonds) is the quantity of the asset that holders of wealth want in their portfolios. depends on its expected return, risk, liquidity, and time to maturity relative to other assets.

Question 24

The supply of each asset

Answer 24

the quantity of that asset that is available. - supplies of individual assets are typically fixed, although over time asset supplies change (e.g., government may issue more bonds, firms may issue new shares, more gold may be mined, etc).

Question 25

money and nonmonetary assets

Answer 25

Money -Pays interest rate 𝑖^𝑚 - Supply is fixed at 𝑀 Nonmonetary assets - Pays interest rate 𝑖=𝑟+𝜋^𝑒 - Supply is fixed at 𝑁𝑀.

Question 26

Asset market equilibrium

Answer 26

quantity of money supplied = quantity of money demanded

Question 27

i. total nominal wealth of an individual ii. aggregate demand for assets/nominal wealth iii. Aggregate supply iv. money supply = money demand

Answer 27

i. 𝑚^𝑑+〖𝑛𝑚〗^𝑑 ii. 𝑀^𝑑+〖𝑁𝑀〗^𝑑 iii. 𝑀+𝑁𝑀 iv. 𝑴=𝑴^𝒅

Question 28

𝑴/𝑷=𝑳(𝒀, 𝒓+𝝅^𝒆 ) left and right hand side of the eq

Answer 28

left-hand side is the real supply of money; the right-hand side is the real demand for money

Question 29

i. asset market determines the price level EQ ii. growth rate form

Answer 29

i. 𝑃=𝑀/𝐿(𝑌, 𝑟+𝜋^𝑒 ) - doubling the money supply would double the price level ii. ∆𝑃/𝑃=∆𝑀/𝑀−∆𝐿(𝑌, 𝑟+𝜋^𝑒 )/𝐿(𝑌, 𝑟+𝜋^𝑒 ) if the asset market is in equilibrium, the inflation rate equals the growth rate of the nominal money supply minus the growth rate of real money demand

Question 30

elasticity of money demand

Answer 30

𝜂_𝑌 𝜋=∆𝑀/𝑀−𝜂_𝑌 ∆𝑌/𝑌

Question 31

If the real interest rate is stable, then nominal interest rate…

Answer 31

will move one for one with inflation.