Week 2 Flashcards
Money Demand; Transactions Theory; Portfolio Theory
Equation for Money Demand
(M/P)^d = L (i,Y)
Money, Price Level, interest rate, Y real income
Quantity thoery of money
Velocity of money and Real income (Y) stay the same then
Theory states that if stock of money and real income say the same then an increase in money supply leads to an increase in price level because more money is chasing the same amount of goods leading to inflation
MV=PY
Keynsian Theory of money demand. Explain the three motives.
Speculative Motive: If people think interest rates will rise they hold money as bonds will lead to capital loss, inverse is true
Transactionary Motive: People need money to spend on everyday things
Precautionary Motive: People save money for unexpected events, the more income the more that saved here
Explain the Baumin-Tobel Model
It is about balancing. Balance what?
It is about how people hold cash for transactionary purposes but also balance their non-liquid asset returns - cash on one hand allows for faster spending but at the loss of gaining interest - non liquid asset gaints interest but at the cost of liquidity aswell as costs when trying to make it liquid such as brokers fee etc
Briefly explain the concept of the portfolio thoery
Essentially it helps investors to understand that diversifying assets can hepl achieve expected return without extremely high risk. Basic concept of high risk high reward applies. Diverisying portfolio with assests that are low or negative correlation means if one fails it does not really affect the other greatly allowing for postive net gain.
What does the portfolio thoery assume?
3 things
Investors are rational
Markets are efficient
Risk is captured by variance
Tobin Mean Variance Model: What is this and what is it’s relation to the Modern Portfolio Theory
TMVM introduces the concept of risk free assests like government bonds into the portfolio which affects its return and risk (variance).
Tobin Mean Variance Model: What is the capital market line and how does this affect investors?
The capital market line shows the optimal mix of risk free assests and risky assets and the combinations possible. The higher on the line the more risky the portfolio is. All portolios still have both risk and risk-free. Investors choose based on preference.
